I.J.M. Arnold

The myth of a stable European money demand

Recent empirical studies suggest that an aggregate EC-wide money demand function is more stable than national money demand functions in the European Community. If true, this would facilitate monetary policy after Economic and Monetary Union. The evidence presented in this paper, however, shows that in general there is no relationship between the size of a currency area and the stability of its demand for money. I conclude that the stability of European money demand is a statistical artifact and has nothing to say about money demand stability in a future larger European currency area.

Fundamental uncertainty and stock market volatility

We provide empirical evidence on the link between stock market volatility and macroeconomic uncertainty. We show that US stock market volatility is significantly related to the dispersion in economic forecasts from participants in the Survey of Professional Forecasters over the period 1969 to 1996. This link is much stronger than that between stock market volatility and the more traditional time-series measures of macroeconomic volatility, but disappears from 1997 onwards. This coincides with a previously documented regime shift in stock volatility. Macroeconomic uncertainty is also able to explain and forecast the volatilities of the Fama and French factors SMB, HML and UMD.

The Vulnerability of Banks to Government Default Risk in the EMU

CThis paper examines the vulnerability of banks in EMU countries to shocks to default risk premiums on public debt. This vulnerability depends on (1) the total amount of public debt in bank portfolios, (2) the extent to which the default risk of public debt of EMU member states is diversifiable, and (3) the degree of actual geographical diversification of public debt holdings by banks. We simulate the effect of country-specific default shocks on the market value of public debt held by banks. The simulations are based on data of public debt positions at the aggregate banking sector level and take into account the historical covariance structure of default risk premiums in the EMU. We compare two scenarios. First, we calculate the domestic public debt. Next, we calculate this effect if banks diversify their investments in public debt across EMU governments. We find that the standard deviation of the equity-to-assets ratio declines considerably if banks diversify their public debt holdings and conclude that the risks of bank failures caused by default on public debt can be reduced through proper geographical diversification. We close with some implications for prudential regulation.

Motivation and math skills as determinants of first-year performance in economics

The importance of math skills for study success in economics has been widely researched. This article adds to the literature by combining information on students’ math skills and their motivation. The authors are thus able to present a rich picture of why students succeed in their study of economics and to confirm previous findings that deficient math preparation bodes ill for first-year study success in economics. However, the authors also find that within the population of math-deficient students, motivation matters. Applying factor analysis to a survey of students at Erasmus School of Economics, the authors identify four motivational factors; among these, intrinsic motivation is most strongly related to first-year study success. The authors also show that intrinsic motivation may help to overcome inadequate preparatory math education.

Firm Size, Industry Mix and the Regional Transmission of Monetary Policy in Germany

Abstract This paper estimates the impact of interest rate shocks on regional output in Germany over the period from 1970 to 2000. We use a vector autoregression (VAR) model to obtain impulse responses, which reveal differences in the output responses to monetary policy shocks across ten German provinces. Next, we investigate whether these differences can be related to structural features of the regional economies, such as industry mix, firm size, bank size and openness. An additional analysis of the volatility of real GDP growth for the period 1992-2000 includes the Eastern provinces. We also present evidence on the interrelationship between firm size and industry, and compare our measure of firm size with those used in previous studies. We conclude that the differential regional effects of monetary policy are related to industrial composition, but not to firm size or bank size.

How Bank Business Models Drive Interest Margins: Evidence from U.S. Bank-Level Data

The two decades prior to the credit crisis witnessed a strategic shift from a traditional, relationships-oriented model (ROM) to a transactions-oriented model (TOM) of financial intermediation in developed countries. A concurrent trend has been a persistent decline in average bank interest margins. In the literature, these phenomena are often explained using a causality that runs from increased competition in traditional segments to lower margins to new activities. Using a comprehensive data set with bank-level data on over 16,000 Federal Deposit Insurance Corporation-insured US commercial banks for a period ranging from 1992 to 2010, this paper qualifies this chain of causality. We find that a banks business model, measured using a multi-dimensional proxy of relationship banking activity, exerts a strong, positive effect on interest margins. Our results suggest that the strategic shift from ROM to TOM has transformed banks’ balance sheets and reduced interest rate margins as a by-product.

Treasury Bond Volatility and Uncertainty about Monetary Policy

We show that dispersion-based uncertainty about the future course of monetary policy is the single most important determinant of Treasury bond volatility across all maturities. The link between Treasury bond volatility and uncertainty about macroeconomic variables is much stronger than for the more traditional time series measures of macroeconomic volatility and adds beyond the information contained in lagged bond market volatility. Uncertainty about monetary policy subsumes the uncertainty about future inflation (consumer price index and the deflator) and economic activity (unemployment, real and nominal gross domestic product and industrial production). In addition, causality clearly runs one way: from monetary policy uncertainty to Treasury bond volatility.

Endogeneity in European money demand

European wide monetary aggregates constructed from pre-unification data cannot be used as evidence that money demand in the euro area is stable. To overcome the Lucas critique, we apply the standard foreign exchange rate model. Since the uncoordinated country specific money supply system is abolished, the increased comovement between local monetary aggregates leaves little room for a free ride on the law of large numbers. Current monetary policy decisions must be based on untested relations, and given ‘the long and variable lags’, we conclude that the road towards monetary stability is a non-activist steady money supply policy.

The effectiveness of academic dismissal policies in Dutch university education: an empirical investigation

This paper uses national data on 450 Dutch bachelor programs to measure the effect of the introduction of academic dismissal policies on study progress and first-year drop-out. Our results show that these policies increase first-year drop-out on average by 6–7%. They also have the effect of improving the study progress of first-year survivors by 5–9%, as measured by their 4-year completion rate. We conclude that academic dismissal policies can be an effective intervention to decrease the study duration of motivated and talented students. Academic dismissal policies thus do not reduce student dropout, but rather bring it forward in time. While these policies strengthen the selective function of the first year, they do little to put dismissed students on a more successful academic path. The referential function of academic dismissal policies therefore needs further strengthening.

External causes of Euro zone inflation differentials

Whether the Economic and Monetary Union (EMU) satisfies the criteria of an optimum currency area (OCA) has been the subject of much debate. Probably the greatest consensus exists on the trade criterion. In general authors conclude from the high levels of intra-EU trade that the European countries are closely interlinked. In that sense, they would constitute an optimal currency area. In this light, recent empirical evidence that external factors such as exchange rates and oil prices are able to explain inflation differentials between EMU countries is surprising. This paper re-examines the evidence using new and revised data and comes to the opposite conclusion.