Fiscal Policy and Fiscal Fragility: Empirical Evidence from the OECD
Makram El-Shagi, Gregor von Schweinitz
Journal of International Money and Finance,
forthcoming
Abstract
In this paper, we use local projections to investigate the impact of consolidation shocks on GDP growth, conditional on the fragility of government finances. Based on a database of fiscal plans in OECD countries, we show that spending shocks are less detrimental than tax-based consolidation. In times of fiscal fragility, our results indicate strongly that governments should consolidate through surprise policy changes rather than announcements of consolidation at a later horizon.
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15.04.2021 • 11/2021
Pandemic delays upswing – Demography slows growth
In their spring report, the leading economic research institutes forecast an increase in gross domestic product of 3.7% in the current year and 3.9% in 2022. The renewed shutdown is delaying the economic recovery, but as soon as the risks of infection, particularly from vaccination, have been averted, a strong recovery will begin. The economy is likely to return to normal output levels around the start of the coming year.
Oliver Holtemöller
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Completing the European Banking Union: Capital Cost Consequences for Credit Providers and Corporate Borrowers
Michael Koetter, Thomas Krause, Eleonora Sfrappini, Lena Tonzer
IWH Discussion Papers,
No. 4,
2021
Abstract
The bank recovery and resolution directive (BRRD) regulates the bail-in hierarchy to resolve distressed banks without burdening tax payers. We exploit the staggered implementation of the BRRD across 15 European Union (EU) member states to identify banks’ capital cost and capital structure responses. In a first stage, we show that average capital costs of banks increased. WACC hikes are lowest in the core countries of the European Monetary Union (EMU) compared to formerly stressed EMU and non-EMU countries. This pattern is driven by changes in the relative WACC weight of equity in response to the BRRD, which indicates enhanced financial system resilience. In a second stage, we document asymmetric transmission patterns of banks’ capital cost changes on to corporates’ borrowing terms. Only EMU banks located in core countries that exhibit higher WACC are those that also increase firms’ borrowing cost and contract credit supply. Hence, the BRRD had unintended consequences for selected segments of the real economy.
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What drives the Commodity-Sovereign-Risk-Dependence in Emerging Market Economies?
Hannes Böhm, Stefan Eichler, Stefan Gießler
Journal of International Money and Finance,
March
2021
Abstract
Using daily data for 34 emerging markets in the period 1994–2016, we find robust evidence that higher export commodity prices are associated with lower sovereign default risk, as measured by lower EMBI spreads. The economic effect is especially pronounced for heavy commodity exporters. Examining the drivers, we find that, first, commodity dependence is higher for countries that export large volumes of commodities, whereas other portfolio characteristics like volatility or concentration are less important. Second, commodity-sovereign risk dependence increases in times of recessions and expansionary U.S. monetary policy. Third, the importance of raw material prices for sovereign financing can likely be mitigated if a country improves institutions and tax systems, attracts FDI inflows, invests in manufacturing, machinery and infrastructure, builds up reserve assets and opens capital and trade accounts. Fourth, the country’s government indebtedness or amount of received development assistance appear to be only of secondary importance for commodity dependence.
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01.02.2021 • 4/2021
During Corona, households are saving more – not for fear of unemployment but for lack of spending opportunities
During the Corona crisis, European households increased their savings dramatically. According to an analysis carried out by the Halle Institute for Economic Research (IWH), the increase in savings is largely due to the inability of households to consume in the face of government lockdown measures, rather than other factors such as economic uncertainty. IWH President Reint Gropp therefore sees potential for a significant catch-up effect in consumption as soon as the lockdown is lifted.
Reint E. Gropp
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Why Are Households Saving so much During the Corona Recession?
Reint E. Gropp, William McShane
IWH Policy Notes,
No. 1,
2021
Abstract
Savings rates among European households have reached record levels during the Corona recession. We investigate three possible explanations for the increase in household savings: precautionary motivations induced by increased economic uncertainty, reduced consumption opportunities due to lockdown measures, and Ricardian Equivalence, i.e. increases in the expected future tax-burden of households driven by increases in government debt. To test these explanations, we compile a monthly panel of euro area countries from January 2019 to August 2020. Our findings indicate that the chief driver of the increase in household savings is supply: As governments restrict households’ opportunities to spend, households spend less. We estimate that going from no lockdown measures to that of Italy’s in March, would have resulted in the growth of Germany’s deposit to Gross Domestic Product (GDP) ratio being 0.6 percentage points higher each month. This would be equivalent to the volume of deposits increasing by roughly 14.3 billion euros or 348 euros per house monthly. Demand effects, driven by either fears of unemployment or fear of infection from COVID-19, appear to only have a weak impact on household savings, whereas changes in government debt are unrelated or even negatively related to savings rates. The analysis suggests that there is some pent-up demand for consumption that may unravel after lockdown measures are abolished and may result in a significant increase in consumption in the late spring/early summer 2021.
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25.01.2021 • 2/2021
High public deficits not only due to the pandemic – Medium-term options for fiscal policy
According to the IWH’s medium-term projection, Germany's gross domestic product will grow more slowly between 2020 and 2025 than before, not only because of the pandemic crisis, but also because the work force will decline. The resulting structural public deficits are, if the legal framework remains unchanged, likely to be higher than the debt brake allows. Consolidation measures, especially if they relate to government revenues, entail economic losses in the short term. “There is much to be said, also from a theoretical point of view, for not abolishing the debt brake, but for relaxing it to some extent,” says Oliver Holtemöller, head of the Department of Macroeconomics and vice president at Halle Institute for Economic Research (IWH).
Oliver Holtemöller
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16.12.2020 • 26/2020
New wave of infections delays economic recovery in Germany
The lockdown is causing production in Germany to decline at the end of the year. When restrictions will be relaxed again, the recovery is likely to pick up pace only slowly, partly because the temporary reduction in value-added taxes is expiring. In spring, milder temperatures and an increasing portion of the population being vaccinated are likely to support the German economy to expand more strongly. The Halle Institute for Economic Research (IWH) forecasts that gross domestic product will increase by 4.4% in 2021, following a 5% decline in 2020. In East Germany, both the decline and the recovery will be significantly less pronounced.
Oliver Holtemöller
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Sovereign Default Risk, Macroeconomic Fluctuations and Monetary-Fiscal Stabilisation
Markus Kirchner, Malte Rieth
IWH Discussion Papers,
No. 22,
2020
Abstract
This paper examines the role of sovereign default beliefs for macroeconomic fluctuations and stabilisation policy in a small open economy where fiscal solvency is a critical problem. We set up and estimate a DSGE model on Turkish data and show that accounting for sovereign risk significantly improves the fit of the model through an endogenous amplication between default beliefs, exchange rate and inflation movements. We then use the estimated model to study the implications of sovereign risk for stability, fiscal and monetary policy, and their interaction. We find that a relatively strong fiscal feedback from deficits to taxes, some exchange rate targeting, or a monetary response to default premia are more effective and efficient stabilisation tools than hawkish inflation targeting.
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How Effective are Bank Levies in Reducing Leverage Given the Debt Bias of Corporate Income Taxation?
F. Bremus, Kirsten Schmidt, Lena Tonzer
SUERF Policy Brief,
No. 21,
2020
Abstract
To finance resolution funds, the regulatory toolkit has been expanded in many countries by bank levies. In addition, these levies are often designed to reduce incentives for banks to rely excessively on wholesale funding resulting in high leverage ratios. At the same time, corporate income taxation biases banks’ capital structure towards debt financing in light of the deductibility of interest on debt. A recent paper published in the Journal of Banking and Finance shows that the implementation of bank levies can significantly reduce leverage ratios, however, only in case corporate income taxes are not too high. The result demonstrates that the effectiveness of regulatory tools can depend upon non-regulatory measures such as corporate taxes, which differ at the country level.
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