Understanding Eurozone Crises: GDP, Employment, & Credit Channels

2. Thepaper (I) • Main objective • Explanation of cross-country GDP and employment growth in the Eurozone (EZ) during the crisis • Using the US experience as a starting point (Mian and Sufi, 2010, Midrigan and Philippon, 2010) • In the EZ: A two-stage story of the crisis (Two stages ?): • 2007-2010: Deleveraging in the private sector • 2010-?: Fiscal consolidation and sovereign crisis • Cross-country differences in household leverage and financing costs to Governments, respectively, can explain cross-country differences in GDP, consumption, and employment growth in 2007-2009 and 2010-2011.

3. Thepaper (II) • Method • Calibration of DSGE model with credit frictions (still preliminary) • “Islands” with representative consumers • Cash-in-advance-constraint with two sources of “money” • Two sectors (tradables, non-tradables) with sector-specific labor • Sticky wages • Intertemporal substitution modeled as adjustment costs to asset holdings • Government and private lenders are perfect substitutes. No monetary policy (M=1). Fiscal transfers providing money. • Extension (and simplification) of Midrigan and Philippon (2010) to account for fiscal policy • Two exogenous shocks: • collateral constraint to private credit • financing costs of Governments

4. Mainquestion • Do the model’s assumptions fit well with the European experience to be explained? • Empirical evidence on the credit-consumption channel • The different nature of the crisis across EZ countries • Asymmetries and imbalances in the EZ • Credit boom, deleveraging and sovereign risk premia

5. COMMENT #1: Relationship between credit and consumption in EUROPE Alberola, Molina and del Rio (2012)

6. COMMENT #1: Relationship between credit and consumption in EUROPE • The role of housing as a source of liquidity • UK : Increases in housing prices led to more borrowing • Bridges, Disney and Gathergood (2009). • DK: Introduction of home equity loans led to increases in consumption. • Leth-Petersen (2010) • Less evidence for other economies, as equity withdrawal less intense • SP: Bover (2005): Estimation of wealth effects. Not very large. • Marques and Nieto (2003): Mortgage refinancing did not increase as a result of higher house prices. (Update: only in 2005 increase in mortgage debt > increase in housing investment) • 2. But even without home equity withdrawals, mortgage credit conditions may affect household consumption (SP:Masier and Villanueva, 2011). • Longer mortgage maturity partly allows to diminish the mortgage payment and increase consumption by recent home owners • Specially important if expect income to be higher later in life • 3. On the downside: Are households/firms credit-constrained? • Disentangling demand-supply of credit • SP:Hernando and Villanueva (2012): “relatively small magnitude of credit supply factors”

9. Leverage as driving consumption: evidence for Spain • Spanish Survey of Household Finances, (EFF 2002, 2005, 2008) • A panel that allows tracking the consumption, labor supply, wealth and debt of households • The evolution of household expenditure in vehicles between 2002 and 2008 by the leverage ratio in 2002 • Some evidence of higher cyclicality of the expenditure in durables among indebted households

11. Mainquestion • Do the model’s assumptions fit well with the European experience to be explained? • Empirical evidence on the credit-consumption channel • SOME EMPIRICAL SUPPORT. LIKELY TO BE RELEVANT. BUT PROBABLY LESS STRONG THAN IN THE US • The different nature of the crisis across EZ countries • Asymmetries and imbalances in the EZ • Credit boom, deleveraging and sovereign risk premia

12. COMMENT #2. Same shock? Same (Labor MARKET) transmission mechanisms? GDP Employment growth (%) vs. GDP growth (2007q2-2010q2)

13. COMMENT #2. Same shock? Same (Labor MARKET) transmission mechanisms? GDP Employment growth (%) vs. GDP growth (20010q2-2011q4)

14. Mainquestion • Do the model’s assumptions fit well with the European experience to be explained? • Empirical evidence on the credit-consumption channel • The different nature of the crisis across EZ countries • DIFFERENT SHOCKS. • DIFFERENT LABOR MARKET RESPONSES DIFFICULT TO EXPLAIN WITH SAME DEGREE OF LABOR MARKET RIGIDITIES ACROSS COUNTRIES • Asymmetries and imbalances in the EZ • Credit boom, deleveraging and sovereign risk premia

15. COMMENT #3. Asymmetries and imbalances • Lower productivity growth in the periphery during 1999-2007… • … and higher wage pressure, led to Alberola, Molina and del Rio (2012)

16. COMMENT #3. Asymmetries and imbalances • …and together with lax fiscal policies to Alberola, Molina and del Rio (2012)

17. COMMENT #3. Asymmetries and imbalances • but could have a more restrictive fiscal policy avoided the increase in external debt? Assume government consumption would have stayed constant, in per capita terms, at its 19981s level for 10 years (Scenario #1) or 20 years (Scenario #2). Beyond 2008 in Scenario #1, 2018 in Scenario #2, government consumption represents again a 17:3% of GDP in each period. Gavilán, Jimeno, Hernandez de Cos, and Rojas (2010)

18. Mainquestion • Do the model’s assumptions fit well with the European experience to be explained? • Empirical evidence on the credit-consumption channel • The different nature of the crisis across EZ countries • Asymmetries and imbalances in the EZ • COMPETITIVENESS, EXTERNAL IMBALANCES ARE KEY TO UNDERSTAND EZ CRISIS • Credit boom, deleveraging and sovereign risk premia

19. COMMENT #4. Sources of shocks • Endogenous leverage • The role of banks (and shadow banking) at generating credit cycles • Nuño and Thomas (2012) • Martinez-Miera and Suarez (2012) • Factors behind the financing cost of EZ Governments ? • Only fiscal variables? • Contagion effects? • Interactions public-private sectors? • Other variables?

20. Financing cost of Governments Spain: 10y bond yield July 7th: 4.71 % July 11th: Spain wins FIFA World Cup August 27th: 3.98 % October 14th: 3.92%

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