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Unit labor cost adjustments since the crisis in GIIPS vs.
BELL countries: The role of central bank liquidity and
rescue pa...
Motivation - Sudden stops in (private) capital flows during
the recent crisis in BELL countries
-2024
2000q1 2004q1 2008q1 ...
Motivation - Sudden stops in (private) capital flows during
the recent crisis in GIIPS countries
-20-100102030
2000q1 2004q...
Motivation
GIIPS and the Eastern European BELL countries (Bulgaria, Estonia, Latvia,
Lithuania) experienced a sudden stop ...
Adjustment in ULC since sudden stop (by country)
0510152025
ULCdependentemployees(%ofpre-crisis)
0 5 10 15 20 25
Quarter s...
Adjustment in ULC since sudden stop (GIIPS vs. BELL)
05101520
ULCdependentemployees(%ofpre-crisis)
0 5 10 15 20 25
Quarter...
Table of contents
1 Introduction
Motivation
Research question, related literature, main contribution
2 Aggregate analysis
...
Research questions
Is there a (significant) difference between GIIPS and BELL countries
regarding the adjustment to recent s...
Existing literature on economic adjustment since the crisis
Generally, our work relates to the literature on sudden stops ...
Main contribution
We base the analysis of the adjustment in ULC on sectoral data.
In particular, nominal and real unit lab...
Table of contents
1 Introduction
Motivation
Research question, related literature, main contribution
2 Aggregate analysis
...
Empirical specification: Adjustment in aggregate ULC -
GIIPS dummy
To quantify the difference in the adjustment process in G...
Estimation results: Adjustment in aggregate ULC - GIIPS
dummy
-20-1001020
0 5 10 15 20
Quarter since sudden stop
95% confi...
Table of contents
1 Introduction
Motivation
Research question, related literature, main contribution
2 Aggregate analysis
...
Refining the empirics - Ingredient I: Sectoral (R)ULC
Identification issue: how to separate currency union membership from s...
Sectoral (R)ULC - Components
ULC can be multiplied by the ratio of total employment to dependent
employees to account for ...
Refining the empirics - Ingredient II: Dependence on
external finance (DEF)
Rationale: adjustment pressure after sudden stop...
Dependence on external finance: pre-sudden stop MFI loan
growth
050100150
SectoralMFIloans(agg.growthratein%,2003q1-2008q3)...
Adjustment in sectoral ULC: High vs. low DEF for GIIPS
and BELL
-4-2024
ULC(%ofpre-crisis)
0 5 10 15 20
Quarter since sudd...
Adjustment in sectoral RULC: High vs. low DEF for GIIPS
and BELL
-20-10010
Realunitlaborcost(%ofpre-crisis)
0 5 10 15 20
Q...
Table of contents
1 Introduction
Motivation
Research question, related literature, main contribution
2 Aggregate analysis
...
Empirical specification: Adjustment in sectoral ULC - The
effect of currency union membership
To identify the impact of curr...
Estimation results: Adjustment in sectoral ULC - The
effect of currency union membership
-20-10010
0 1 2 3 4 5 6 7 8 9 10 1...
Estimation results: Adjustment in sectoral RULC - The
effect of currency union membership
-40-30-20-100
0 1 2 3 4 5 6 7 8 9...
Estimation results: Adjustment in real wages - The effect
of currency union membership
-60-40-20020
0 1 2 3 4 5 6 7 8 9 10 ...
Estimation results: Adjustment in nominal wages - The
effect of currency union membership
-10-505
0 1 2 3 4 5 6 7 8 9 10 11...
Estimation results: Adjustment in labor productivity - The
effect of currency union membership
-20-1001020
0 1 2 3 4 5 6 7 ...
Estimation results: Adjustment in prices - The effect of
currency union membership
-1001020
0 1 2 3 4 5 6 7 8 9 10 11 12 13...
Table of contents
1 Introduction
Motivation
Research question, related literature, main contribution
2 Aggregate analysis
...
The effect of currency union membership and the role of
central bank liquidity
The estimated parameters measure the effect o...
The role of central bank liquidity: Target2 balances
-50005001000
Target2balances(EURbn.)
2008q1 2009q1 2010q1 2011q1 2012...
Empirical specification: Adjustment in sectoral ULC - The
role of central bank liquidity
In order to relate the effect to en...
Estimation results: Adjustment in sectoral ULC - The role
of central bank liquidity
-10-50510
0 1 2 3 4 5 6 7 8 9 10 11 12...
Estimation results: Adjustment in sectoral RULC - The role
of central bank liquidity
-30-20-1001020
0 1 2 3 4 5 6 7 8 9 10...
Table of contents
1 Introduction
Motivation
Research question, related literature, main contribution
2 Aggregate analysis
...
Robustness: Rescue programs and other variables
International rescue programs, inflation differentials, and devaluation
expe...
Estimation results: Robustness ULC - The effect of
currency union membership
Dependent variable:
ULC adjustment (% of pre-c...
Estimation results: Robustness ULC - The role of central
bank liquidity
Dependent variable:
ULC adjustment (% of pre-crisi...
Estimation results: Robustness RULC - The effect of
currency union membership
Dependent variable:
RULC adjustment (% of pre...
Estimation results: Robustness RULC - The role of central
bank liquidity
Dependent variable:
RULC adjustment (% of pre-cri...
Concluding remarks
We identify the differential effect of currency union membership on
adjustment in nominal and real sector...
Concluding remarks
We find evidence that this effect goes indeed beyond the common currency
as it can robustly be related to...
Appendix: Estimation results: Adjustment in ULC - The
effect of currency union membership - Alternative DEF
measure
-60-40-...
Appendix: Estimation results: Adjustment in RULC - The
effect of currency union membership - Alternative DEF
measure
-80-60...
Appendix: Estimation results: Adjustment in ULC - The
role of central bank liquidity - Alternative DEF measure
-30-20-1001...
Appendix: Estimation results: Adjustment in RULC - The
role of central bank liquidity - Alternative DEF measure
-60-40-200...
Appendix: Estimation results: Adjustment in real wages -
The role of central bank liquidity
-40-2002040
0 1 2 3 4 5 6 7 8 ...
Appendix: Estimation results: Adjustment in nominal
wages - The role of central bank liquidity
-6-4-202
0 1 2 3 4 5 6 7 8 ...
Appendix: Estimation results: Adjustment in labor
productivity - The role of central bank liquidity
-10-5051015
0 1 2 3 4 ...
Appendix: Estimation results: Adjustment in prices - The
role of central bank liquidity
-10-5051015
0 1 2 3 4 5 6 7 8 9 10...
Appendix: How to interpret Target2 balances?
Brought to attention by Sinn and Wollmershäuser (2011). In particular in the
...
Appendix: Target2 balances in the Balance of Payments
and sudden stops in private capital flows
Sudden increase in Target2 ...
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Claudia M. Buch, Manuel Buchholz, Alexander Lipponer, Esteban Prieto. Unit labor cost adjustments since the crisis in GIIPS vs. BELL countries: The role of central bank liquidity and rescue packages

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Open Seminar, Eesti Pank 19.02.2015

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Claudia M. Buch, Manuel Buchholz, Alexander Lipponer, Esteban Prieto. Unit labor cost adjustments since the crisis in GIIPS vs. BELL countries: The role of central bank liquidity and rescue packages

  1. 1. Unit labor cost adjustments since the crisis in GIIPS vs. BELL countries: The role of central bank liquidity and rescue packages Claudia M. Buch 1 Manuel Buchholz 2 Alexander Lipponer 1 Esteban Prieto 1 1 Deutsche Bundesbank 2 Halle Institute for Economic Research (IWH) Open Seminar Eesti Pank Feb 19, 2015 The views expressed in the presentation are those of the authors and do not necessarily reflect the views of the Deutsche Bundesbank or its staff. Buch, Buchholz, Lipponer, Prieto ULC adjustments GIIPS vs. BELL Feb 19, 2015 1 / 42
  2. 2. Motivation - Sudden stops in (private) capital flows during the recent crisis in BELL countries -2024 2000q1 2004q1 2008q1 2012q1 Quarter BG -.4-.20.2.4.6 2000q1 2004q1 2008q1 2012q1 Quarter EE -1-.50.511.5 2000q1 2004q1 2008q1 2012q1 Quarter LT -1-.50.511.5 2000q1 2004q1 2008q1 2012q1 Quarter LV Net private capital inflows (EUR bn.) Data source: Eurostat. Net private capital inflows are defined as total net capital inflows according to financial account. No adjustments for official rescue programs. Vertical red line indicates sudden stop period. Country legend: BG Bulgaria; EE Estonia, LT Lithuania; LV Latvia. Buch, Buchholz, Lipponer, Prieto ULC adjustments GIIPS vs. BELL Feb 19, 2015 2 / 42
  3. 3. Motivation - Sudden stops in (private) capital flows during the recent crisis in GIIPS countries -20-100102030 2000q1 2004q1 2008q1 2012q1 Quarter EL -150-100-50050 2000q1 2004q1 2008q1 2012q1 Quarter ES -50050 2000q1 2004q1 2008q1 2012q1 Quarter IE -100-50050100 2000q1 2004q1 2008q1 2012q1 Quarter IT -30-20-10010 2000q1 2004q1 2008q1 2012q1 Quarter PT Net private capital inflows (EUR bn.) Data source: Eurostat and Eurocrisismonitor.com. Net private capital inflows are defined as total net capital inflows according to financial account minus increase in Target2 liabilities (data from Eurocrisismonitor.com). Vertical red line indicates sudden stop period. No adjustments for official rescue programs. Country legend: EL Greece, ES Spain; IE Ireland; IT Italy; PT Portugal. Buch, Buchholz, Lipponer, Prieto ULC adjustments GIIPS vs. BELL Feb 19, 2015 3 / 42
  4. 4. Motivation GIIPS and the Eastern European BELL countries (Bulgaria, Estonia, Latvia, Lithuania) experienced a sudden stop in private capital flows during the recent crisis. Historically, the resulting adjustment pressure due to a sudden stop often made countries devalue their currency; however, GIIPS countries were members of currency union and each of the BELL countries kept the peg to the Euro throughout the crisis. Adjustment has taken place via internal devaluation, which is e.g. visible in the development of unit labor cost (ULC) since the crisis (see e.g. Staehr, 2012 (Baltics), Blanchard et al., 2013 (Latvia)). There are notable differences between the adjustment paths of GIIPS and BELL countries. Buch, Buchholz, Lipponer, Prieto ULC adjustments GIIPS vs. BELL Feb 19, 2015 4 / 42
  5. 5. Adjustment in ULC since sudden stop (by country) 0510152025 ULCdependentemployees(%ofpre-crisis) 0 5 10 15 20 25 Quarter since sudden stop BG EE EL ES IE IT LT LV PT Data source: Eurostat. Variable is defined in terms of adjustment, i.e. an increase (decrease) corresponds to a reduction (increase) in ULC. Country legend: BG Bulgaria; EE Estonia, EL Greece, ES Spain; IE Ireland; IT Italy; LT Lithuania; LV Latvia; PT Portugal. Buch, Buchholz, Lipponer, Prieto ULC adjustments GIIPS vs. BELL Feb 19, 2015 5 / 42
  6. 6. Adjustment in ULC since sudden stop (GIIPS vs. BELL) 05101520 ULCdependentemployees(%ofpre-crisis) 0 5 10 15 20 25 Quarter since sudden stop GIIPS BELL Data source: Eurostat. Variable is defined in terms of adjustment, i.e. an increase (decrease) corresponds to a reduction (increase) in ULC. Country legend: BG Bulgaria; EE Estonia, EL Greece, ES Spain; IE Ireland; IT Italy; LT Lithuania; LV Latvia; PT Portugal. Buch, Buchholz, Lipponer, Prieto ULC adjustments GIIPS vs. BELL Feb 19, 2015 6 / 42
  7. 7. Table of contents 1 Introduction Motivation Research question, related literature, main contribution 2 Aggregate analysis Empirical specification Estimation results 3 Sectoral analysis Refining the empirics Sectoral ULC Dependence on external finance The effect of currency union membership Empirical specification Estimation results The role of central bank liquidity Empirical specification Estimation results Robustness Rescue programs and other variables Estimation results 4 Concluding remarks Buch, Buchholz, Lipponer, Prieto ULC adjustments GIIPS vs. BELL Feb 19, 2015 7 / 42
  8. 8. Research questions Is there a (significant) difference between GIIPS and BELL countries regarding the adjustment to recent sudden stops? If so, is this difference related to membership in the currency union (Euro Area)? Identification issue: separate country-specific factors (e.g. labor market flexibility, openness) from Euro Area membership. Sectoral data will prove useful in this respect. Given that the differences are not linked to currency per se (BELL pegged): What is the role of access to liquidity provided by the ECB and rescue packages? Buch, Buchholz, Lipponer, Prieto ULC adjustments GIIPS vs. BELL Feb 19, 2015 8 / 42
  9. 9. Existing literature on economic adjustment since the crisis Generally, our work relates to the literature on sudden stops and macroeconomic adjustment (e.g. Calvo, 1998, Calvo and Mendoza, 1996, 2000). A couple of papers with focus on EA have recently emerged. Lindner (2011), Gros and Alcidi (2013), Hansson and Randveer (2013) give an comprehensive overview on the differences in the adjustment paths in GIIPS and Baltic/BELL countries. consider key economic variables such as GDP, the current account, consumption, and exports. discuss the role of access to Eurosystem liquidity and rescue packages. Tressel and Wang (2014) argue that adjustment in current accounts in GIIPS countries partly due to structural but mainly cyclical factors. Kang and Shambaugh (2014) directly compare GIIPS and Baltic countries. find that unit labor cost adjustment can to some extent be attributed to productivity gains but was mainly due to falling employment. Buch, Buchholz, Lipponer, Prieto ULC adjustments GIIPS vs. BELL Feb 19, 2015 9 / 42
  10. 10. Main contribution We base the analysis of the adjustment in ULC on sectoral data. In particular, nominal and real unit labor costs are considered. As well as their components: (real/nominal) wages, prices, labor productivity. We assume that adjustment pressure should be higher in sectors which depend more strongly on external finance. Our empirical specification allows disentangling the effect of Euro Area membership from country-specific (demand) factors as well as sectoral shocks. We relate the difference due to Euro Area membership to enhanced liquidity provision by the ECB during the crisis (reflected in the built up of comparatively large Target2 imbalances) and financial assistance/rescue packages during the crisis. Buch, Buchholz, Lipponer, Prieto ULC adjustments GIIPS vs. BELL Feb 19, 2015 10 / 42
  11. 11. Table of contents 1 Introduction Motivation Research question, related literature, main contribution 2 Aggregate analysis Empirical specification Estimation results 3 Sectoral analysis Refining the empirics Sectoral ULC Dependence on external finance The effect of currency union membership Empirical specification Estimation results The role of central bank liquidity Empirical specification Estimation results Robustness Rescue programs and other variables Estimation results 4 Concluding remarks Buch, Buchholz, Lipponer, Prieto ULC adjustments GIIPS vs. BELL Feb 19, 2015 11 / 42
  12. 12. Empirical specification: Adjustment in aggregate ULC - GIIPS dummy To quantify the difference in the adjustment process in GIIPS compared to BELL countries, we use the following specification: ULC-Adjustit = αi + αt + γt[Dt × DGIIPS] + εit (1) ULC-Adjustit: percentage change in the unit labor costs since the sudden stop period relative to pre-sudden-stop level. Note that the sign is reverted such that positive values in adjustment reflect a reduction in unit labor costs. Country-specific sudden stop periods (last quarter before sudden stop) EL: 2007q4; IE: 2008q1; IT: 2011q2; PT: 2010q1; ES: 2011q2 BG: 2008q4; EE: 2008q3; LV: 2008q3; LT: 2008q3 DGIIPS: GIIPS dummy Dt: dummy indicating a specific quarter since the sudden stop γt: captures difference in adjustment between GIIPS and BELL countries Buch, Buchholz, Lipponer, Prieto ULC adjustments GIIPS vs. BELL Feb 19, 2015 12 / 42
  13. 13. Estimation results: Adjustment in aggregate ULC - GIIPS dummy -20-1001020 0 5 10 15 20 Quarter since sudden stop 95% confidence bands Coefficient Note: Coefficient is γt from equation (1). Dependent variable is defined in terms of adjustment, i.e. an increase (decrease) corresponds to a reduction (increase) in ULC. Buch, Buchholz, Lipponer, Prieto ULC adjustments GIIPS vs. BELL Feb 19, 2015 13 / 42
  14. 14. Table of contents 1 Introduction Motivation Research question, related literature, main contribution 2 Aggregate analysis Empirical specification Estimation results 3 Sectoral analysis Refining the empirics Sectoral ULC Dependence on external finance The effect of currency union membership Empirical specification Estimation results The role of central bank liquidity Empirical specification Estimation results Robustness Rescue programs and other variables Estimation results 4 Concluding remarks Buch, Buchholz, Lipponer, Prieto ULC adjustments GIIPS vs. BELL Feb 19, 2015 14 / 42
  15. 15. Refining the empirics - Ingredient I: Sectoral (R)ULC Identification issue: how to separate currency union membership from sector and country-specific factors and shocks? Sectoral data can prove useful in this respect. We use data from Eurostat on 9 sectors based on the NACE (Revision 2) classification. The sample period spans 2007q4 to 2013q3 with country specific sudden stop periods. The (nominal) ULC in sector k of country i are computed using sectoral data on total compensation for employees and real gross value added (GVA). ULCik = LaborCostik LaborProductivityik = TotalCompensationik TotalHoursWorkedik RealGVAik TotalHoursWorkedik = TotalCompensationik RealGVAik Real unit labor costs (RULC) are given by: RULCik = ULCik/Pik = TotalCompensationik NominalGVAik Where Pik is the sectoral price deflator. Buch, Buchholz, Lipponer, Prieto ULC adjustments GIIPS vs. BELL Feb 19, 2015 15 / 42
  16. 16. Sectoral (R)ULC - Components ULC can be multiplied by the ratio of total employment to dependent employees to account for the number of self-employed people (see, e.g., Tressel and Wang, 2014): ULCadj,ik = ULCik × TotalEmployment (pers.)ik TotalDepEmployees (pers.)ik Applying log differences, (approximate) percentage changes in ULC can be decomposed into the following components: %∆ULCadj,ik ≈ %∆RULCik + %∆Pik = %∆RealWageik − %∆LaborProductivityik + %∆Pik Thus, in addition to nominal and real ULC, we investigate adjustment in real and nominal wages, sectoral price deflators and labor productivity. Buch, Buchholz, Lipponer, Prieto ULC adjustments GIIPS vs. BELL Feb 19, 2015 16 / 42
  17. 17. Refining the empirics - Ingredient II: Dependence on external finance (DEF) Rationale: adjustment pressure after sudden stops is likely to be higher in sectors which are more dependent on external finance. Idea: measure for dependence on external finance (DEF) in the spirit of Rajan and Zingales (1998). Link to capital flows: Prasad et al. (2007). However: no such measure is available for the NACE classification on the level of aggregation given in our data. We propose two measures for sectoral dependence on external finance (DEF): The aggregate growth rate of MFI loans in given sector pre crisis 2003q1-2008q3 (Source: ECB SDW). Only variation across sectors not countries. The fraction of firms in need for external loan finance pre-crisis (in 2007) taken from the “Access to finance survey” conducted by Eurostat. Variation across sectors and countries. However, smaller sample with fewer countries. Buch, Buchholz, Lipponer, Prieto ULC adjustments GIIPS vs. BELL Feb 19, 2015 17 / 42
  18. 18. Dependence on external finance: pre-sudden stop MFI loan growth 050100150 SectoralMFIloans(agg.growthratein%,2003q1-2008q3) 1 2 3 4 5 6 8 9 10 11 Sector legend: 1 Agriculture; 2 Industry; 3 Manufacturing; 4 Construction; 5 Trade; 6 Information; 7 Financial (no data); 8 Real Estate; 9 Science; 10 Public Admin; 11 Arts Buch, Buchholz, Lipponer, Prieto ULC adjustments GIIPS vs. BELL Feb 19, 2015 18 / 42
  19. 19. Adjustment in sectoral ULC: High vs. low DEF for GIIPS and BELL -4-2024 ULC(%ofpre-crisis) 0 5 10 15 20 Quarter since sudden stop GIIPS -4-2024 ULC(%ofpre-crisis) 0 5 10 15 20 Quarter since sudden stop BELL DEF: low DEF: high Note: time-varying sector and country fixed effects partialled out. Dependence on external finance (DEF) measure is based on pre-sudden stop MFI loan growth. Variable is defined in terms of adjustment, i.e. an increase (decrease) corresponds to a reduction (increase) in ULC. Buch, Buchholz, Lipponer, Prieto ULC adjustments GIIPS vs. BELL Feb 19, 2015 19 / 42
  20. 20. Adjustment in sectoral RULC: High vs. low DEF for GIIPS and BELL -20-10010 Realunitlaborcost(%ofpre-crisis) 0 5 10 15 20 Quarter since sudden stop GIIPS -20-10010 Realunitlaborcost(%ofpre-crisis) 0 5 10 15 20 Quarter since sudden stop BELL DEF: low DEF: high Note: time-varying sector and country fixed effects partialled out. Dependence on external finance (DEF) measure is based on pre-sudden stop MFI loan growth. Variable is defined in terms of adjustment, i.e. an increase (decrease) corresponds to a reduction (increase) in ULC. Buch, Buchholz, Lipponer, Prieto ULC adjustments GIIPS vs. BELL Feb 19, 2015 20 / 42
  21. 21. Table of contents 1 Introduction Motivation Research question, related literature, main contribution 2 Aggregate analysis Empirical specification Estimation results 3 Sectoral analysis Refining the empirics Sectoral ULC Dependence on external finance The effect of currency union membership Empirical specification Estimation results The role of central bank liquidity Empirical specification Estimation results Robustness Rescue programs and other variables Estimation results 4 Concluding remarks Buch, Buchholz, Lipponer, Prieto ULC adjustments GIIPS vs. BELL Feb 19, 2015 21 / 42
  22. 22. Empirical specification: Adjustment in sectoral ULC - The effect of currency union membership To identify the impact of currency union membership on adjustment, we use the following specification: ULC-Adjustikt = αkτ + αiτ + αit + αkt + βDEFik + γt [Dt × DEFik × DGIIPS] + εit (2) k: sector; t: quarter since sudden stop; τ: actual quarter. The parameter γt captures the differential effect of currency union membership on adjustment given a higher sectoral dependence on external finance: γt = ∆ULC-Adjustik,t−t0 ∆DGIIPS DEF=d+1 − ∆ULC-Adjustik,t−t0 ∆DGIIPS DEF=d The specification controls for i) time-varying country-specific (αit) and ii) time-varying sector-specific (αkt) effects. Standard errors are clustered at the country-sector level. Buch, Buchholz, Lipponer, Prieto ULC adjustments GIIPS vs. BELL Feb 19, 2015 22 / 42
  23. 23. Estimation results: Adjustment in sectoral ULC - The effect of currency union membership -20-10010 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 Quarter since sudden stop 90% confidence bands Coefficient Note: DEF measure is based on pre-sudden stop MFI loan growth. Coefficient is γt from equation (2). Dependent variable is defined in terms of adjustment, i.e. an increase (decrease) corresponds to a reduction (increase) in ULC. Buch, Buchholz, Lipponer, Prieto ULC adjustments GIIPS vs. BELL Feb 19, 2015 23 / 42
  24. 24. Estimation results: Adjustment in sectoral RULC - The effect of currency union membership -40-30-20-100 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 Quarter since sudden stop 90% confidence bands Coefficient Note: DEF measure is based on pre-sudden stop MFI loan growth. Coefficient is γt from equation (2). Dependent variable is defined in terms of adjustment, i.e. an increase (decrease) corresponds to a reduction (increase) in RULC. Buch, Buchholz, Lipponer, Prieto ULC adjustments GIIPS vs. BELL Feb 19, 2015 24 / 42
  25. 25. Estimation results: Adjustment in real wages - The effect of currency union membership -60-40-20020 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 Quarter since sudden stop 90% confidence bands Coefficient Note: DEF measure is based on pre-sudden stop MFI loan growth. Coefficient is γt from equation (2). Dependent variable is defined in terms of adjustment, i.e. an increase (decrease) corresponds to a reduction (increase) in real wages. Buch, Buchholz, Lipponer, Prieto ULC adjustments GIIPS vs. BELL Feb 19, 2015 25 / 42
  26. 26. Estimation results: Adjustment in nominal wages - The effect of currency union membership -10-505 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 Quarter since sudden stop 90% confidence bands Coefficient Note: DEF measure is based on pre-sudden stop MFI loan growth. Coefficient is γt from equation (2). Dependent variable is defined in terms of adjustment, i.e. an increase (decrease) corresponds to a reduction (increase) in nominal wages. Buch, Buchholz, Lipponer, Prieto ULC adjustments GIIPS vs. BELL Feb 19, 2015 26 / 42
  27. 27. Estimation results: Adjustment in labor productivity - The effect of currency union membership -20-1001020 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 Quarter since sudden stop 90% confidence bands Coefficient Note: DEF measure is based on pre-sudden stop MFI loan growth. Coefficient is γt from equation (2). Buch, Buchholz, Lipponer, Prieto ULC adjustments GIIPS vs. BELL Feb 19, 2015 27 / 42
  28. 28. Estimation results: Adjustment in prices - The effect of currency union membership -1001020 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 Quarter since sudden stop 90% confidence bands Coefficient Note: DEF measure is based on pre-sudden stop MFI loan growth. Coefficient is γt from equation (2). Dependent variable is defined in terms of adjustment, i.e. an increase (decrease) corresponds to a reduction (increase) in prices. Buch, Buchholz, Lipponer, Prieto ULC adjustments GIIPS vs. BELL Feb 19, 2015 28 / 42
  29. 29. Table of contents 1 Introduction Motivation Research question, related literature, main contribution 2 Aggregate analysis Empirical specification Estimation results 3 Sectoral analysis Refining the empirics Sectoral ULC Dependence on external finance The effect of currency union membership Empirical specification Estimation results The role of central bank liquidity Empirical specification Estimation results Robustness Rescue programs and other variables Estimation results 4 Concluding remarks Buch, Buchholz, Lipponer, Prieto ULC adjustments GIIPS vs. BELL Feb 19, 2015 29 / 42
  30. 30. The effect of currency union membership and the role of central bank liquidity The estimated parameters measure the effect of being a GIIPS as opposed to a BELL country beyond any impact of country-specific or industry-specific demand factors or any other shocks in these dimensions. We can therefore plausibly argue that the remaining effect has to be due to another difference between BELL and GIIPS countries, which is the membership in the Euro Area. This effect does not capture a difference in currencies as the BELL countries pegged their currency to the Euro and kept the peg throughout the observed period. The relevant difference is rather one of access to central bank liquidity. Data on Target2 balances provide us with an adequate measure when and to which extent banks in the Euro periphery have drawn on central bank credit to substitute for dried up private capital inflows. Buch, Buchholz, Lipponer, Prieto ULC adjustments GIIPS vs. BELL Feb 19, 2015 30 / 42
  31. 31. The role of central bank liquidity: Target2 balances -50005001000 Target2balances(EURbn.) 2008q1 2009q1 2010q1 2011q1 2012q1 2013q1 2014q1 quarter DE EL ES IE IT PT Source: Eurocrisismonitor.com Buch, Buchholz, Lipponer, Prieto ULC adjustments GIIPS vs. BELL Feb 19, 2015 31 / 42
  32. 32. Empirical specification: Adjustment in sectoral ULC - The role of central bank liquidity In order to relate the effect to enhanced liquidity provided by the ECB, we introduce Target2 liabilities (relative to GDP) into the specification: ULC-Adjustikt = αkτ + αiτ + αit + αkt + βDEFik + γt [Dt × DEFik × Target2it] + εit (3) Data on Target2 balances is from the Deutsche Bundesbank. Data on Target2 balances is also made available on the website Eurocrisismonitor.com run by the Institute of Empirical Economic Research of Osnabrück University (Steinkamp/Westermann). Buch, Buchholz, Lipponer, Prieto ULC adjustments GIIPS vs. BELL Feb 19, 2015 32 / 42
  33. 33. Estimation results: Adjustment in sectoral ULC - The role of central bank liquidity -10-50510 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 Quarter since sudden stop 90% confidence bands Coefficient Note: DEF measure is based on pre-sudden stop MFI loan growth. Coefficient is γt from equation (3). Dependent variable is defined in terms of adjustment, i.e. an increase (decrease) corresponds to a reduction (increase) in ULC. Buch, Buchholz, Lipponer, Prieto ULC adjustments GIIPS vs. BELL Feb 19, 2015 33 / 42
  34. 34. Estimation results: Adjustment in sectoral RULC - The role of central bank liquidity -30-20-1001020 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 Quarter since sudden stop 90% confidence bands Coefficient Note: DEF measure is based on pre-sudden stop MFI loan growth. Coefficient is γt from equation (3). Dependent variable is defined in terms of adjustment, i.e. an increase (decrease) corresponds to a reduction (increase) in RULC. Buch, Buchholz, Lipponer, Prieto ULC adjustments GIIPS vs. BELL Feb 19, 2015 34 / 42
  35. 35. Table of contents 1 Introduction Motivation Research question, related literature, main contribution 2 Aggregate analysis Empirical specification Estimation results 3 Sectoral analysis Refining the empirics Sectoral ULC Dependence on external finance The effect of currency union membership Empirical specification Estimation results The role of central bank liquidity Empirical specification Estimation results Robustness Rescue programs and other variables Estimation results 4 Concluding remarks Buch, Buchholz, Lipponer, Prieto ULC adjustments GIIPS vs. BELL Feb 19, 2015 35 / 42
  36. 36. Robustness: Rescue programs and other variables International rescue programs, inflation differentials, and devaluation expectations in BELL countries might systematically affect adjustment (conditional on DEF). Is the effect of currency union membership robust to inclusion of these variables? To answer this question, we use a specification with constant γ: ULC-Adjustikt = αkτ + αiτ + αit + αkt + β1DEFik + DEFik × [γDGIIPS + β2 xit] + εit (4) xit reflects included control variables. The parameter γ captures the average differential effect of currency union membership over the whole estimation period. Equivalently, to check robustness for the role of central bank liquidity: ULC-Adjustikt = αkτ + αiτ + αit + αkt + β1DEFik + DEFik × [γTarget2it + β2 xit] + εit (5) Buch, Buchholz, Lipponer, Prieto ULC adjustments GIIPS vs. BELL Feb 19, 2015 36 / 42
  37. 37. Estimation results: Robustness ULC - The effect of currency union membership Dependent variable: ULC adjustment (% of pre-crisis) (1) (2) (3) (4) (5) DEF x REER -2.733*** -2.960** (1.035) (1.226) DEF x NEER 1.633 1.081 (1.502) (1.365) DEF x 3M-Fwd. Exch. Rate -0.729 0.019 (1.051) (0.886) DEF x RescueProgram/GDP -0.444*** -0.468*** (0.130) (0.138) DEF x DGIIPS -4.048 0.199 -4.020 -4.849 -0.613 (4.723) (4.087) (4.705) (4.609) (3.754) Country-time FE x x x x x Sector-time FE x x x x x Obs 1,449 1,395 1,449 1,449 1,395 R-squared 0.59 0.61 0.59 0.59 0.62 Note: DEF measure is based on pre-sudden stop MFI loan growth. Cluster-robust SE at country-sector level. ∗∗∗ , ∗∗ , ∗ denotes significance at the 1%, 5%, and 10% level. Dependent variable is defined in terms of adjustment, i.e. an increase (decrease) corresponds to a reduction (increase) in ULC. Buch, Buchholz, Lipponer, Prieto ULC adjustments GIIPS vs. BELL Feb 19, 2015 37 / 42
  38. 38. Estimation results: Robustness ULC - The role of central bank liquidity Dependent variable: ULC adjustment (% of pre-crisis) (1) (2) (3) (4) (5) DEF x REER -3.197** -3.352** (1.327) (1.581) DEF x NEER 1.631 0.748 (1.562) (1.573) DEF x 3M-Fwd. Exch. Rate -0.316 -0.335 (0.354) (0.318) DEF x RescueProgram/GDP -5.754*** -5.952*** (1.684) (1.779) DEF x Target2Liab/GDP -0.680 2.273 -0.651 -1.046 1.978 (2.010) (1.473) (1.996) (2.010) (1.424) Country-time FE x x x x x Sector-time FE x x x x x Obs 1,395 1,395 1,395 1,395 1,395 R-squared 0.57 0.62 0.57 0.58 0.63 Note: DEF measure is based on pre-sudden stop MFI loan growth. Cluster-robust SE at country-sector level. ∗∗∗ , ∗∗ , ∗ denotes significance at the 1%, 5%, and 10% level. Dependent variable is defined in terms of adjustment, i.e. an increase (decrease) corresponds to a reduction (increase) in ULC. Explanatory variables are standardized (zero mean, unit standard deviation). Buch, Buchholz, Lipponer, Prieto ULC adjustments GIIPS vs. BELL Feb 19, 2015 38 / 42
  39. 39. Estimation results: Robustness RULC - The effect of currency union membership Dependent variable: RULC adjustment (% of pre-crisis) (1) (2) (3) (4) (5) DEF x REER -0.096 0.183 (1.530) (1.660) DEF x NEER 1.294 1.433 (1.829) (1.837) DEF x 3M-Fwd. Exch. Rate -2.174 -2.389 (1.997) (2.333) DEF x RescueProgram/GDP 0.067 0.072 (0.216) (0.227) DEF x DGIIPS -16.024** -16.549** -15.941** -15.944*** -16.253** (6.145) (7.513) (6.100) (5.975) (7.120) Country-time FE x x x x x Sector-time FE x x x x x Obs 1,449 1,395 1,449 1,449 1,395 R-squared 0.59 0.60 0.59 0.59 0.60 Note: DEF measure is based on pre-sudden stop MFI loan growth. Cluster-robust SE at country-sector level. ∗∗∗ , ∗∗ , ∗ denotes significance at the 1%, 5%, and 10% level. Dependent variable is defined in terms of adjustment, i.e. an increase (decrease) corresponds to a reduction (increase) in RULC. Buch, Buchholz, Lipponer, Prieto ULC adjustments GIIPS vs. BELL Feb 19, 2015 39 / 42
  40. 40. Estimation results: Robustness RULC - The role of central bank liquidity Dependent variable: RULC adjustment (% of pre-crisis) (1) (2) (3) (4) (5) DEF x REER -0.907 -0.774 (1.530) (1.588) DEF x NEER 2.922* 3.099 (1.656) (1.866) DEF x 3M-Fwd. Exch. Rate -0.225 -0.065 (0.426) (0.404) DEF x RescueProgram/GDP 2.106 2.172 (2.566) (2.661) DEF x Target2Liab/GDP -8.632*** -9.818** -8.611*** -8.624*** -9.816** (3.246) (4.187) (3.238) (3.146) (4.080) Country-time FE x x x x x Sector-time FE x x x x x Obs 1,368 1,368 1,368 1,368 1,368 R-squared 0.62 0.62 0.62 0.62 0.63 Note: DEF measure is based on pre-sudden stop MFI loan growth. Cluster-robust SE at country-sector level. ∗∗∗ , ∗∗ , ∗ denotes significance at the 1%, 5%, and 10% level. Dependent variable is defined in terms of adjustment, i.e. an increase (decrease) corresponds to a reduction (increase) in RULC. Explanatory variables are standardized (zero mean, unit standard deviation). Buch, Buchholz, Lipponer, Prieto ULC adjustments GIIPS vs. BELL Feb 19, 2015 40 / 42
  41. 41. Concluding remarks We identify the differential effect of currency union membership on adjustment in nominal and real sectoral unit labor to a sudden stop in private capital flows. To shut down the currency devaluation channel, the empirical specification directly compares GIIPS and BELL countries. In addition, the sectoral analysis allows separating the effect from any country and sector specific factors/shocks. With respect to the effect of currency union membership on adjustment in real unit labor costs (RULC), we find that it is negative (i.e. unit labor costs reduced by less) for most periods, which points towards a slowdown effect. it is economically significant: up to 25% lower (cumulative) adjustment in some periods (per one std. dev. higher DEF measure). it is conditional on higher sectoral dependence on external finance, which is in line with economic reasoning. the confidence bands are rather wide in the flexible specification, but it is highly statistically significant in simpler specification. it is robust to inclusion of other relevant variables such as the amount of EU/IMF rescue funds. Buch, Buchholz, Lipponer, Prieto ULC adjustments GIIPS vs. BELL Feb 19, 2015 41 / 42
  42. 42. Concluding remarks We find evidence that this effect goes indeed beyond the common currency as it can robustly be related to national central banks’ Target2 liabilities, which reflect to which extent banks in the Euro periphery have substituted dried up private capital inflows with central bank liquidity. However, the effect of currency union membership on adjustment appears to be less obvious for nominal unit labor cost and labor productivity and does not translate to sectoral price deflators. Policy implication: General role of currency union in adjustment process after sudden stop? Buch, Buchholz, Lipponer, Prieto ULC adjustments GIIPS vs. BELL Feb 19, 2015 42 / 42
  43. 43. Appendix: Estimation results: Adjustment in ULC - The effect of currency union membership - Alternative DEF measure -60-40-20020 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 Quarter since sudden stop 90% confidence bands Coefficient Note: DEF measure is based on proportion of firms in need for (loan) finance in 2007. Buch, Buchholz, Lipponer, Prieto ULC adjustments GIIPS vs. BELL Feb 19, 2015 43 / 42
  44. 44. Appendix: Estimation results: Adjustment in RULC - The effect of currency union membership - Alternative DEF measure -80-60-40-20020 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 Quarter since sudden stop 90% confidence bands Coefficient Note: DEF measure is based on proportion of firms in need for (loan) finance in 2007. Buch, Buchholz, Lipponer, Prieto ULC adjustments GIIPS vs. BELL Feb 19, 2015 44 / 42
  45. 45. Appendix: Estimation results: Adjustment in ULC - The role of central bank liquidity - Alternative DEF measure -30-20-10010 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 Quarter since sudden stop 90% confidence bands Coefficient Note: DEF measure is based on proportion of firms in need for (loan) finance in 2007. Buch, Buchholz, Lipponer, Prieto ULC adjustments GIIPS vs. BELL Feb 19, 2015 45 / 42
  46. 46. Appendix: Estimation results: Adjustment in RULC - The role of central bank liquidity - Alternative DEF measure -60-40-20020 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 Quarter since sudden stop 90% confidence bands Coefficient Note: DEF measure is based on proportion of firms in need for (loan) finance in 2007. Buch, Buchholz, Lipponer, Prieto ULC adjustments GIIPS vs. BELL Feb 19, 2015 46 / 42
  47. 47. Appendix: Estimation results: Adjustment in real wages - The role of central bank liquidity -40-2002040 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 Quarter since sudden stop 90% confidence bands Coefficient Note: DEF measure is based on pre-sudden stop MFI loan growth. Buch, Buchholz, Lipponer, Prieto ULC adjustments GIIPS vs. BELL Feb 19, 2015 47 / 42
  48. 48. Appendix: Estimation results: Adjustment in nominal wages - The role of central bank liquidity -6-4-202 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 Quarter since sudden stop 90% confidence bands Coefficient Note: DEF measure is based on pre-sudden stop MFI loan growth. Buch, Buchholz, Lipponer, Prieto ULC adjustments GIIPS vs. BELL Feb 19, 2015 48 / 42
  49. 49. Appendix: Estimation results: Adjustment in labor productivity - The role of central bank liquidity -10-5051015 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 Quarter since sudden stop 90% confidence bands Coefficient Note: DEF measure is based on pre-sudden stop MFI loan growth. Buch, Buchholz, Lipponer, Prieto ULC adjustments GIIPS vs. BELL Feb 19, 2015 49 / 42
  50. 50. Appendix: Estimation results: Adjustment in prices - The role of central bank liquidity -10-5051015 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 Quarter since sudden stop 90% confidence bands Coefficient Note: DEF measure is based on pre-sudden stop MFI loan growth. Buch, Buchholz, Lipponer, Prieto ULC adjustments GIIPS vs. BELL Feb 19, 2015 50 / 42
  51. 51. Appendix: How to interpret Target2 balances? Brought to attention by Sinn and Wollmershäuser (2011). In particular in the beginning debate on how to correctly interpret Target2 balances (Sinn and Wollmershäuser, 2011, 2012, Wheelan, 2011, Buiter et al. 2011). To a certain extent, views have recently converged. Target2 balances reflect asymmetric liquidity needs of banks across Euro Area countries (see, e.g., Blinseil and König, 2011). These needs are encountered by enhanced liquidity provision by the ECB (full allotment policy, reduced collateral standards). They are a monitor for malfunctioning of private capital markets in Europe and thus a crisis indicator (see website Eurocrisismonitor.com by Steinkamp/Westermann, Ulbrich and Lipponer, 2012). Peculiarities: Official rescue packages settled via Target 2 reduce liabilities: however, not necessarily a sign of relaxation of crisis. ⇒ adjust Target2 balances Buch, Buchholz, Lipponer, Prieto ULC adjustments GIIPS vs. BELL Feb 19, 2015 51 / 42
  52. 52. Appendix: Target2 balances in the Balance of Payments and sudden stops in private capital flows Sudden increase in Target2 liabilites (e.g. structural break) can be interpreted as a sudden stop in private capital flows (see, e.g., Tornell and Westermann, 2011, Merler and Pisany-Ferry, 2012). Balance of Payments, Financial Account (simplified): TotalCapitalInflows = PrivateCapitalInflows − ∆Target2Balance + EU/IMF net inflows − ∆ForeignReserves. Thus, given an erosion of private capital inflows, the change in Target2 liabilities has to make up for repatriated funds from abroad as well as capital outflows by residents for total capital inflows to stay constant (see, e.g., Cour-Thimann, 2013). Increase in Target2 liabilities is thus a measure of when and to which extent banks have substituted dried up private capital inflows with liquidity provided by the central bank. Buch, Buchholz, Lipponer, Prieto ULC adjustments GIIPS vs. BELL Feb 19, 2015 52 / 42

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