The EMU sovereign-debt crisis: Fundamentals, expectations and contagion

We offer a detailed empirical investigation of the European sovereign debt crisis based on the theoretical model by Arghyrou and Tsoukalas (2010). We find evidence of a marked shift in market pricing behaviour from a ‘convergence-trade’ model before August 2007 to one driven by macro-fundamentals and international risk thereafter. The majority of EMU countries have experienced contagion from Greece. There is no evidence of significant speculation effects originating from CDS markets. Finally, the escalation of the Greek debt crisis since November 2009 is confirmed as the result of an unfavourable shift in country specific market expectations. Our findings highlight the necessity of structural, competitiveness-inducing reforms in periphery EMU countries and institutional reforms at the EMU level enhancing intra-EMU economic monitoring and policy co-ordination.

Real exchange rates and current account imbalances in the Euro-area

Global current account imbalances have been one of the focal points of interest for policymakers during the last few years. Less attention has been paid, however, to the growing imbalances within the Euro-area. In the short period since the commencement of the EMU two distinct groups of member state have emerged: those with consistently improving current accounts and those with consistently worsening current accounts. In this paper we consider the dynamics of current account adjustment and the role of real exchange rates in current account determination in the EMU member countries. Monetary union participation, which entails giving up the nominal exchange rate, can make the correction of current account imbalances more cumbersome. While most theoretical models of open economies rely on a causal relationship between real exchange rates and the current account limited, if any, contemporary evidence exist on the empirical validity of this relationship. We find that the above relationship is substantial in size and subject to pronounced non-linear effects. We identify two groups of countries since the abandonment of European national currencies: those with persistent real exchange rate depreciation leading to current account improvement; and those with systematic real appreciation and deteriorating current accounts. These groups largely correspond to those previous research has identified as respectively belonging and not belonging to a European Optimum Currency Area. Our findings validate the theoretical arguments concerning the potential costs of EMU participation and suggest that meeting the nominal convergence criteria has come, in some countries, at the cost of growing current account imbalances. The latter pose policy-response questions for national authorities and the ECB, suggesting that it may be optimal to add to the EMU-accession criteria one referring to the balance of the current account; and highlighting the importance of increasing the flexibility of relative prices to facilitate real exchange rate and current account adjustmentcurrent account, real exchange rate, EMU, nonlinearities

The EMU sovereign-debt crisis: Fundamentals, expectations and contagion

We offer a detailed empirical investigation of the European sovereign debt crisis based on the theoretical model by Arghyrou and Tsoukalas (2010). We find evidence of a marked shift in market pricing behaviour from a ‘convergence-trade’ model before August 2007 to one driven by macro-fundamentals and international risk thereafter. The majority of EMU countries have experienced contagion from Greece. There is no evidence of significant speculation effects originating from CDS markets. Finally, the escalation of the Greek debt crisis since November 2009 is confirmed as the result of an unfavourable shift in countryspecific market expectations. Our findings highlight the necessity of structural, competitiveness-inducing reforms in periphery EMU countries and institutional reforms at the EMU level enhancing intra-EMU economic monitoring and policy co-ordination.euro-area, crisis, spreads, fundamentals, expectations, contagion, speculation.

Government Solvency: Revisiting some EMU Countries

Corsetti and Roubini (1991) reported that the government finances of Greece, Ireland, Italy and the Netherlands (now all EMU countries) did not satisfy the intertemporal budget constraint (IBC). We re-examine this issue by utilizing a new empirical approach and extended data set. Structural shifts, an issue which Corsetti and Roubini were unable to address due to the lack of suitable econometric methods, are tackled. We find that: (i) multiple structural shifts, most of which correspond to important policy changes, did occur in the fiscal path of these countries; (ii) the effect of the majority of structural shifts has been to strengthen the evidence supporting IBC; and (iii) government finances of all four countries satisfy the IBC and this finding is robust to different time horizons. We also find a clear positive Maastricht effect on IBC for all countries.intertemporal budget constraints, strong and weak form sustainability, structural breaks

Corruption as a form of extreme individualism: An economic explanation based on geography and climate conditions

We present a simple model explaining corruption on geography and climate conditions. We test the model's validity in a cross-section of 115 countries. Controlling for all other corruption's determinants we find evidence supporting the model's predictions. Corruption increases with temperature and declines with precipitation and non-cultivatable land. Corruption also declines with per capita GDP, democracy, median age and British colonial heritage; and increases with natural resources, bureaucracy and communist past. Finally, corruption declines with the ratio of internet users to total population. This new finding is interpreted as capturing the beneficial interaction of economic development, human capital/education and independent news

The Greek Debt Crisis: Likely Causes, Mechanics and Outcomes

We use insights from the literature on currency crises to offer an analytical treatment of the crisis in the market for Greek government bonds. We argue that the crisis itself and its escalating nature are very likely to be the result of: (a) steady deterioration of Greek macroeconomic fundamentals over 2001-2009 to levels inconsistent with long-term EMU participation; and (b) a double shift in markets’ expectations, from a regime of credible commitment to future EMU participation under an implicit EMU/German guarantee of Greek fiscal liabilities, to a regime of non-credible EMU commitment without fiscal guarantees, respectively occurring in November 2009 and February/March 2010. We argue that the risk of contagion to other periphery EMU countries is significant; and that without extensive structural reforms the sustainability of the EMU is in question.currency crises, bonds market, expectations, fiscal guarantees, contagion

Monetary policy before and after the euro: Evidence from Greece

We model Greek monetary policy in the 1990s and use our findings to address two interrelated questions. First, how was monetary policy conducted in the 1990s so that the hitherto highest-inflation EU country managed to join the euro by 2001? Second, how compatible is the current ECB monetary policy with Greek economic conditions? We find that Greek monetary policy in the 1990s was: (i) primarily determined by foreign (German/ECB) interest rates though still influenced, to some degree, by domestic fundamentals; (ii) involving non-linear output gap effects; (iii) subject to a deficit of credibility culminating in the 1998 devaluation. On the question of compatibility our findings depend on the value assumed for the equilibrium post-euro real interest rate and overall indicate both a reduction in the pre-euro risk premium and some degree of monetary policy incompatibility. Our analysis has policy implications for the new EU members and motivates further research on fast-growing EMU economies

Structural reforms in the euro area: a Greek view

Events in recent years have put the European economic integration project and the euro under pressure. The main cause of the euro crisis is loss of competitiveness, particularly on the periphery of the Economic and Monetary Union. To reverse this, Union members must promote structural reforms that increase long-term employment, productivity and external competitiveness. The successful implementation of reforms, however, requires sufficient public support, which in turn presupposes measures that support demand during the implementation of reforms. To that end, important steps include taking an expenditure-based approach to fiscal adjustment and the introduction of the European Deposit Insurance Scheme. And for Greece in particular, the set of necessary steps includes taking ownership of reforms, the downward revision of fiscal targets, and medium- and long-term measures of debt relief conditional upon meeting fiscal/reform targets. Finally, the stability of the euro hinges on the moderation of all fiscal and external imbalances across all member states, regardless of whether these imbalances are apparent or not