Current account core-periphery dualism in the EMU. Tatiana Cesaroni (Bank of Italy) and Roberta De Santis (Istat)

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1 Current account core-periphery dualism in the EMU Tatiana Cesaroni (Bank of Italy) and Roberta De Santis (Istat)

2 Motivation (i) starting from the beginning of 90ies Eurozone CA as a whole has remained almost balanced on the contrary dispersion among EZ members has been increasing. CA deficits in the peripheral countries have been complemented by growing surpluses in some core countries core periphery dualism. CA dispersion within the EZ countries determined by the European financial integration process (Blanchard and Giavazzi, 2002 easier access to the capital market of the peripheral countries).

3 Motivation (ii) the massive foreign capital allocation in the EZ countries with higher expected return demonstrates that the EMU is a well integrated capital market.. the home bias reduction produced by the capital outflows from core to peripheral countries seems not to have produced an endogeneous CA rebalancing as neoclassical and OCA theories predict. lack of Governance? lack of OCA endogeneity properties in the EMU?

4 Aim of the paper (i) to analyze, next to the traditional determinants, the impact of European financial integration on CA imbalances ; to compare the behavior of the core and peripheral countries; to analyze the effects of the European Governance using a set of qualitative indicators.

5 What is new? to analyze the causes of Eurozone core periphery CA dualism with a focus on financial integration indicators; to perform a robustness excercise that considers different econometric techniques, countries subsets, and time sample periods. to include in the estimates qualitative indicators in order to assess the effects of the «governance» on CA balance.

6 Some stylized facts (i) wth recovering Current account (% of GDP) Source: OECD EZ USA Japan

7 Some stylized facts (ii) Current account (%GDP) Source:OECD "core" av. "periphery" av.

8 Some stylized facts (iii) Current account* (%GDP) Source:OECD "core" av. "periphery" av. Italy Germany * the core average excludes Germany and the core periphery excludes Italy

9 Some stylized facts (vi) Average Current Account before and after EMU aust. belg. finl. fran. neth. gre. irel. port. spa. germ. italy Source: OECD

10 Data sources and sample selection (i) 22 OECD members, (15 EU, 11 EZ economies) are selected in the sample. EZ countries in two groups: core (Germany, Austria, The Netherlands, Belgium, Finland and France) and periphery (Italy, Spain, Portugal, Ireland and Greece); annual data coming from OECD, Milesi Ferretti (2011) database, The Fraser Institute and The World Bank; time sample spans from Starting year 1986 (European Single Act), 2012 is the latest available year for most of the series in the dataset.

11 Data sources and sample selection (ii) explanatory variables of CA in four groups: i) macroeconomic fundamentals and control variables, ii) dummies, iii) financial integration and capital openness indicators iv) governance indicators. i) income per capita, fiscal balance, output gap, real oil price, real effective exchange rate. ii) dummies for European financial integration and dummies for countries subsets. iii) de iure Chinn-Ito index of capitals movement restrictions and de facto financial integration.

12 Data sources and sample selection (iii) iv) governance qualitative indicators: 1. Word Bank Governance indicators (available from 2002): voice and accountability; regulatory quality; government effectiveness. 2. The Fraser Institute indicators (available from 2000): capital controls ; credit market regulation ; corruption; private sector credit.

13 Econometric strategy, equation (i) The estimated equation is the following: CA it = β i + β 1 REEX it 1 + β 2 bcy it + β 3 I(k)finopen it + β 4 I k fisbal it + β 5 Z it where: CA is the CA balance to GDP ratio in nominal US$ ; REEX is the lagged real effective exchange rate; bcy is a proxy of the business cycle (output gap); fisbal is the public budget balance divided by GDP; finopen is the financial openness indicator; Z includes indicators of real oil prices, income per capita, internal distance, geographical area and governance.

14 Econometric strategy, equation (ii) CA it = β i + β 1 REEX it 1 + β 2 bcy it + β 3 I(k)finopen it + β 4 I k fisbal it + β 5 Z it I(k) is a binary indicator accounting for interaction effects among groups of countries that takes the value one (and zero otherwise) for : a. countries belonging to core (k = 1), b. countries belonging to periphery (k = 2), and c. countries belonging to the OECD but not to the core or periphery (k = 3).

15 Mod. 1 Estimates results CA determinants N. of groups 21 OECD EU N. of obs F-E H-T GMM-SYS F-E H-T GMM-SYS Ca it *** 0.87*** Constant 6.90*** 11.40** *** 19.25** *** fiscalbal i*ocse_ez 0.21*** 0.22 *** 0.05 fiscalbal *core 0.26** 0.26*** ** 0.23** 0.04 fiscalbal *periphery ** *** b cycle.it -0.36*** -0.37*** -0.21*** -0.28*** *** -0.13*** REEXit *** -0.12*** -0.04*** -0.17*** -0.16*** fin openi*ocse_ez 2.39*** 2.24*** 0.27 fin open*core fin openi*periphery -1.22*** -1.23*** -0.60*** *** -1.12*** -0.40** EMU *** *** *** -1.97*** Z it oilprice -0.03*** -0.03*** -0.03*** *** -0.03*** -0.03*** Income per capita 0.00*** 0.00 *** 0.00 *** 0.00*** 0.00 *** 0.00 *** Distance Area

16 Estimates results Model 1 Looking at the estimates results for OECD and EU countries in the whole sample ( ) we find that : REEX and bcy are significant and with the expected negative signs; the fiscal balance has a positive and significant sign for the OECD_nonEZ and core countries confirming for them the Twin deficit hypothesis ; the financial integration indicator seems to have a positive impact on CA for the OECD_nonEZ countries. The impact for periphery countries is negative and significant. This result holds for both OECD and EU groups estimates; the EMU dummy has a negative and significant impact on CA; the results seems to corroborate the view that the CA dispersion in the periphery was determined to some extent by capital inflows due to the European integration process;

17 Mod 2 Estimates results CA determinants (FE) Model F-E OECD EU EU ex Italy and Germany Number of groups Number of observation Constant fiscalbal OECD _ EZit 0.23*** fiscalbal it *core 0.88*** 0.89*** 0.91*** fiscalbal it *periphery bcycle.it -0.50*** -0.53*** -0.56*** REEXit ** fin open1oecd_ez1i fin open1*core 0.3* 0.33* 0.30 fin open1*periphery -0.27** -0.27** -0.28** EMU Zit Income per capita 0.00*** 0.00*** 0.00*** Oil price -0.04*** -0.04*** -0.04***

18 Estimates results model 2 (ii) in table 2 we look at estimates results for OECD and EU countries and EU excluding Italy and Germany in the EMU sample ( ). For fiscal balance and bcy the results are consistent with the findings related to the whole sample ( ). Competitiveness is not significant in the EMU period for the EU sample. The bcy has a greater role in explaining the CA balance in the post Euro. As for the financial integration indicator all the previous results are confirmed. The exclusion of Italy and Germany keeps the empirical results substantially unchanged.

19 Estimates results (iii) CA determinants in EU countries FE model Full sample Financial integration sample Post EMU sample Constant 14.34*** 9.09** ** 0.30** 0.89*** fiscalbal it *core fiscalbal it *periphery bcycle.it REEXit- 1 fin open1*core -0.15** ** -0.41*** -0.53*** -0.16*** -0.12*** * -0.13** -0.16** -0.27** fin open1*periphery Zit Income per capita Oil price 0.000*** 0.00*** 0.00*** -0.03*** -0.03*** -0.04***

20 Estimates results: time samples comparison (iii) In table 3 we look at estimates results for the EU countries subsets in three different time samples ( , and ): business cycle: seems to play a negative increasing role over time; fiscal balance: in the core group we find evidence of an increasing role in explaining CA in the EMU period. The coefficient increases from 0.3 (in ) to 0.9 (in ); Financial integration indicator: i) the magnitude of the coefficient for the periphery almost doubled in the post euro period; ii) the coefficient for the core countries becomes significant starting from the creation of the EMU.

21 CA Elasticity to main explanatory variables Full sample Financial integration sample Post EMU sample bcycle.it REEXt fiscalbal it *core fiscalbal it *periphery fin openi1*core fin openi1*periphery

22 Impact analysis we assess the contribution of core and periphery countries explanatory variables to the model prediction. we evaluate the contribution of the various regressors to overall CA variation between 1999 and 2007 (2008 is the year of the crisis). the sum of the contribution is equal to the model s predicted value. we also report the actual and predicted values of CA growth rates over the period for each country. to perform the impact exercise we consider the regression coefficients reported in column 3 (post-emu sample) of table 5.

23 Contributions to CA of different components

24 Mod 3 Est. results CA and the governance EU countries (2000/2-12) Model 1 Model 2 Model 3 Model 4 Model 5 Model 6 Model7 Constant ** -9.33** * fiscalbal it *core 0.71*** 0.95*** 1.1*** 0.74*** 1.00*** 0.93*** 0.73*** fiscalbal it *periphery -0.14* * REEXi t * ** ** bcycle.it -0.46*** -0.49*** -0.43*** -0.42*** -0.60*** -0.47*** -0.44*** fin openi1*core ** 0.42* fin openi1*periphery -0.46*** 0.31** -0.29*** -0.28*** -0.32** -0.25** -0.27** Income per capita 0.46*** 0.24** 0.49*** 0.49*** 0.21** 0.28** 0.49*** Oil price -0.03** *** -0.04*** -0.03** -0.03* -0.04*** corruption 1.72*** gov. effectiveness** 3.52** capital mkt reg 0.40 capital control 0.32 voice and accountability** 4.71** reg. quality indicators** priv. sect credit 0.23*

25 Estimates results We include in the estimates the governance indicators starting from 2000/2: government effectiveness, voice and accountability and private sector credit enter with a positive coefficient and are significant in the whole EU group; corruption reduction is statistically significant in the whole EU group and as expected contributes to improve CA balance.

26 Conclusions (i) According to our estimates and in line with the prevailing theoretical and empirical literature, financial integration seems to have played an role in explaining CA dynamics both in the main OECD and EU countries groups. In the EZ and differentiating the impact of financial integration for core and peripheral countries we find evidence of a statistically significant negative impact in the EZ periphery. Moreover this negative relationship seems to have increased in the post euro period. These empirical findings proved to be robust to changes in econometric techniques, specifications, time and countries samples.

27 Conclusions (ii) CA deficits in the peripheral EMU countries could have been determined to some extent by the increase of capital inflows triggered by the intensification of the European financial integration process. The EMU was effective in creating a well-integrated capital market, but the home bias reduction in the European financial market did not favored an endogenous process of convergence and rebalancing as neoclassical and OCA theories predict. This finding suggests that the recent reforms of European governance designed to create stricter European surveillance procedures, by reducing asymmetric CA imbalances in the Eurozone, could improve the effectiveness of centralized policies.

28 Thank you for your attention

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