Bernd Kempa

International correlations and excess returns in European stock markets: Does EMU matter?

The paper analyses the international correlations of the European national stock markets and identifies the potential excess returns which can be reaped by means of international diversification in the emerging European stock market relative to a strategy of purely national diversification both before and after EMU comes into effect. To facilitate a comparison of the pre- and post-EMU effects of international diversification, we construct an EMU index-portfolio as an average of the national stock market indices weighted by the respective national market capitalizations. The performance of the national indices is then compared to the EMU index-portfolio with and without an explicit incorporation of FX volatility. It is found that the excess returns of holding an efficiently diversified European stock market portfolio are positive throughout, with the highest potential for excess returns for Austria, Finland and Italy. However, the results generally indicate that the gains of international diversification are more substantial in the presence of FX volatility. Nevertheless, the national betas are also generally higher when exchange rate variability is accounted for, indicating that the elimination of FX volatility in the wake of EMU is likely to lower to cost of equity in national stock markets.

Is Europe converging to optimality? On dynamic aspects of optimum currency areas

This paper investigates whether Europe is converging towards becoming an optimum currency area. To this end, a structural vector autoregression with exclusively long‐run exclusion restrictions is employed on European bilateral real exchange rates, relative CPIs and real output to compare the incidence of the underlying shocks to aggregate supply, aggregate demand and the money market over time. Inferences on historical convergence are drawn for the EU15, the 11 countries originally participating in the European Monetary Union (EMU11) and the original members of the exchange rate mechanism of the EMS (EMS6). The results indicate significant convergence across the EU.

Excess volatility of real exchange rates in the EMS: Some evidence from structural VARs

This paper argues that the effectiveness of the exchange rate mechanism (ERM) of the European Monetary System (EMS) should be gauged by its impact on the monetary component of real exchange rate variability. Nominal and real shocks are separated using a bivariate structural VAR applied to real exchange rate data of the six original member countries participating in the ERM and a control group consisting of Britain and the United States. The findings suggest that monetary shocks have been an important source of real exchange rate variability and that the ERM has been successful in reducing the incidence of monetary shocks across its member countries prior to the EMS currency crises of 1992–93, while being less successful thereafter.

Sticky Prices and Alternative Monetary Feedback Rules: How Robust is the Overshooting Phenomenon?

The present paper incorporates a mechanism of rules-based central-bank interventions into a Dornbusch-type framework. We show that the implied reactions of exchange rates and interest and interest rate differentials in response to a monetary shock depend crucially on the particular monetary policy feedback rule. The Dornbusch case of postively correlated and overshooting nominal and real exchange rates as well as nominal and real interest rate differentials is only one of the possible scenarios of our model. Different scenarios imply zero and negative correlations and even multiple overshooting. [E58, F31, F41]

Misalignments of real exchange rates and the credibility of nominal currency bands

Misalignments of Real Exchange Rates and the Credibility of Nominal Currency Bands. — This paper analyzes a sticky-price target zone model in which realignment risk is modeled endogenously as a function of the degree of real exchange rate misalignments. The implications of the model are used to investigate the credibility of selected nominal ERM exchange rate bands. We find that a lack of credibility of the ERM currency bands occurs mostly in countries with substantial swings and persistent misalignments of real exchange rates. These findings suggest that the major real appreciations in some European bilateral real exchange rates between 1987 and 1992 have been pivotal in triggering the ERM currency crises of 1992 and 1993.ZusammenfassungFehlanpassung realer Wechselkurse und die Glaubwürdigkeit von nominalen Wechselkursbandbreiten. — Die Verfasser analysieren ein Zielzonen-modell mit starren Preisen, in welchem das Risiko von Wechselkursanpassungen endogen modelliert wird als Funktion des Ausma\es der Fehlanpassungen realer Wechselkurse. Die Folgerungen aus dem Modell werden genutzt, um die Glaubwürdigkeit ausgewÄhlter nominaler Bandbreiten im europÄischen Wechselkursmechanismus zu unter-suchen. Die Verfasser zeigen, da\ ein Mangel an Glaubwürdigkeit meistens in den LÄndern vorkommt, die starke Schwankungen und anhaltende Fehlanpassungen der realen Wechselkurse aufweisen. Diese Ergebnisse deuten darauf hin, da\ die wesentlichen realen Aufwertungen einiger bilateraler Wechselkurse in Europa zwischen 1987 und 1992 entscheidend an der Auslösung der WÄhrungskrisen im europÄischen Wechselkursme-chanismus von 1992 und 1993 beteiligt waren.

The term structure of interest rates in a sticky-price target zone model

Abstract The term structure of interest rates in a sticky-price target zone model with perfectly credible marginal central bank intervention is identified by means of an arbitage-free valuation. We find that an explicit credible target zone for the exchange rate is associated with an implicit target zone for the long-term interest rate where the nonlinearity of the exchange rate function translates into a corresponding stabilizing nonlinearity of the long-term interest rate. Imposing a target zone reduces the variability of short-term and long-term interest rates and induces a steeper term structure relative to freely floating exchange rates.

An analytical approximation of target zone exchange rate functions: The technique of collocation

Abstract This paper applies the analytical approximation technique of collocation to the stochastic sticky-price exchange rate target zone model. The technique can be used to trace out the resulting nonlinear exchange rate path with remarkable accuracy while requiring comparatively little computational effort.

Government debt and economic growth in the G7 countries: are there any causal linkages?

ABSTRACT This article investigates the direction of Granger-causality between debt and growth in the G7 countries using quarterly data from 1980 to 2013. We analyse the causal structure both in level data using the Toda and Yamamoto causality test, and with differenced data by means of dynamic impulse response analysis. Results indicate that growth causes debt rather than the other way around. We find the effect of growth on debt to be unambiguously negative in all cases of significant causality, but to be a short- to medium-run phenomenon with no lasting impact. We also find that results are sensitive to the sample period, with causality from growth to debt much more prevalent when the sample period includes the recent financial crisis.

Global and Country-Specific Output Growth Uncertainty and Macroeconomic Performance†

We identify global and country-specific measures of output growth uncertainty for a large OECD country sample by means of a dynamic factor model with stochastic volatility. We find evidence for major bouts of global uncertainty in the early 1970s and late 2000s, and a number of periods with elevated levels of either global or national uncertainty, particularly in the early 1980s, 1990s and 2000s. VAR impulse responses of national macroeconomic variables to our estimated measures of uncertainty reveal that global uncertainty is the major driver of macroeconomic performance in most countries, whereas the impact of national uncertainty is small and frequently insignificant. We also find that uncertainty is transmitted primarily through investment and trade flows rather than through consumption demand.

On the size of government spending multipliers in Europe

This article compares the size of government spending multipliers in Europe by applying a panel structural vector autoregression analysis on 11 eurozone and 8 non-eurozone countries using quarterly data from 1991Q1 to 2012Q4. We find that (i) spending multipliers are smaller in eurozone compared to non-eurozone countries, (ii) across the euro area the impact of government spending on GDP has been higher before than after the introduction of the euro, (iii) spending multipliers are larger in the eurozone periphery than in the core countries and (iv) since the beginning of the recent financial crisis, spending multipliers have become larger both for eurozone and for non-eurozone countries. We relate these results to an emerging theoretical literature linking the size of fiscal multipliers to the monetary policy stance. We also discuss the implications of our findings for the effectiveness of fiscal policy in Europe.