Sven Langedijk

Reviewing Adjustment Dynamics in EMU: From Overheating to Overcooling

This paper analyses how adjustment dynamics, in an environment with some degree of price and wage rigidity, may create and strengthen asymmetric developments in a monetary union. It presents a simple illustrative model of adjustment dynamics that reproduces quite nicely actual developments in the first years of EMU. The model is used to analyse adjustments to two types of shocksrelative competitiveness shifts and demand disturbances. It is shown that the interaction between real exchange rate adjustment and real interest rate developments may contribute to periods of overheating and overcooling during which output might be for a number of years either above or below potential.Furthermore, the paper looks at the circumstances in which smooth adjustment to shocks can be expected and, on the other hand, when a cycle with greater amplitude is more likely. Finally, the paper examines policy options that could improve the functioning of EMU. The analysis provides another strong argument for pressing ahead with reforms that increase flexibility in labour and product markets and further integrate the economies of the euro area.

Debt Bias in Corporate Taxation and the Costs of Banking Crises in the EU

During the period 2008-2012, EU governments incurred substantial costs bailing out banks. As corporate income taxation (CIT) in most countries still favors debt- over equityfinancing, reducing or eliminating this debt bias would complement regulatory reforms reducing costs of financial crises. To estimate this effect, we use a two-step approach. First, using panel regressions on a dataset of 32,833 bank-year observations we find sizable long-run effects of CIT on leverage in the EU. Second, we simulate the effect of tax reforms on bank losses using a Vasicek-based model with actual banks’ balance sheets to estimate costs of systemic crises for six large EU member states. Even if the tax elasticity of bank leverage is taken at the lower end of the ranges found in recent literature, eliminating the debt bias could lead to reductions of public finance losses in the range of 60 to 90%. The results hold even when considering much smaller effects for banks that are close to the regulatory minimum capital requirement of the Basel III framework. Even when asset portfolio risk is allowed to increase endogenously and considering conservative ranges of the parameter space, we conclude that tax reforms to remove the debt bias can result in very sizable reductions in risks and costs of financial crises.

Benchmarking Liquidity Proxies: Accounting for Dynamics and Frequency Issues

We revisit a central task of the extant liquidity literature, which is to identify effective measures of liquidity. We critically assess the influential practice of identifying the best liquidity measures based on monthly correlations by comparing and contrasting correlations between monthly and daily averages of high-frequency benchmarks and low-frequency proxies of liquidity, as well as by examining the coherences between such measures. Furthermore, we propose MIDAS regressions as a way of investigating the bilateral relationships between benchmarks and proxies without averaging out potentially valuable high-frequency information, as is common practice. We conclude that the empirical correlations between benchmarks and proxies in general become weaker as the frequency over which these relationships are examined becomes higher, and that standard practices may lead to misleading conclusions. One implication of our results is that any liquidity measure needs to be assessed against the relevant timeframe for conversion into cash.

Banking Stress Scenarios for Public Debt Projections

The euro area sovereign debt crisis brought to light the potential risks to public finances posed by the banking sector. This paper simulates the potential impact of bank defaults on public finances based on stress test scenarios using an advance analytical methodology.

Imbalances Versus Fundamentals -- An Econometric Analysis of House Prices in Ireland

In the past two decades the Irish real estate market experienced the most pronounced housing boom-bust cycle among all OECD countries. In this paper, we propose a model for residential real estate prices in Ireland distinguishing the effect of fundamental drivers and imbalances. We use a cointegration framework with yearly data from 1975 to 2013. The framework adds to existing literature by capturing the impact of mortgage lending through a proxy variable which overcomes a number of shortcomings in recent studies. We find that increasing disposable income and demographic factors have been the main fundamental drivers of house prices during the boom, while lower mortgage interest rates and increased mortgage lending also contributed significantly to skyrocketing real estate prices. During the bust, the sharp decline in mortgage lending was the single most important factor in the house price collapse, exceeding the effects of falling disposable income and reduced population growth due to the reversal of migration flows. Based on econometric estimations we found that during the bust, real estate prices undershot the ‘equilibrium’ price level significantly.