title: Essays on Capital Flows and External Imbalances in the Euro Area
Creators: name: Kraus, Lena
Publisher: name: University of Bayreuth
Year: 2020
Subjects: subject: Fiscal devaluation
subject: Welfare
subject: External Imbalances
subject: Monetary Union
subject: Eurosystem Payment System
subject: TARGET2
subject: Sudden Stop
subject: Deleveraging
subject: Capital Flows
subject: Safe Assets
subject: 330

description: The central research question of this thesis is the macroeconomic adjustment to external imbalances within the euro area. In particular, the thesis examines (i) the potential of internal devaluation to combat external imbalances within the euro area, and (ii) the specific role of the Eurosystem's interbank payment system TARGET2 in the adjustment to a reversal of capital inflows and the associated current account imbalances. Finally, the thesis (iii) provides a model implementation of euro area-wide safe assets to reduce banks' exposure to domestic sovereigns. After a brief introduction in Chapter 1, Chapter 2 investigates the welfare effects of a fiscal devaluation, i.e., a budgetary-neutral tax shift from employers' social security contributions towards consumption tax, that mimics the effects of external devaluation. Using a small open economy model, this chapter finds that fiscal devaluation can support external rebalancing by accelerating real exchange rate adjustments. However, internal devaluation tends to induce welfare losses for households due to a worsening of the terms of trade. The losses increase with the tax shift, the openness of the economy and the relative size of the tradable sector. Chapter 3 analyzes sharp reversals of private capital flows. Examining macroeconomic ad-justments to sudden stops in a small open economy DSGE model, we compare sudden stops in euro area Member States that have access to TARGET2 and, as a benchmark, countries pegged to the euro. We emphasize the crucial role of the exchange rate regime with two main findings: Public capital flows in form of TARGET2 have stabilizing effects in euro area defi-cit countries in the short run. In the long run, however, they suffer under a prolonged economic recovery and larger public debt as well as higher welfare losses relative to euro peggers. Chapter 4 builds upon the TARGET2 mechanism in Chapter 3, but extends the framework to an estimated two-region DSGE model of core and peripheral euro area countries, to capture potential interregional feedback effects. The liquidity provision to peripheral banks by the Eurosystem gives rise to divergent developments across the two regions: In periphery, TARGET2 liabilities mitigate the effects of a sudden stop and private deleveraging for consumers due to beneficial terms of trade, while domestic output declines. Core countries, on the other hand, increase their exports and thus output while imports decrease. The distributional effects of TARGET2 lead to persistent real exchange rate misalignments between the regions. Chapter 5 presents a first DSGE model approach to integrate euro area-wide safe assets in a two-region (core and periphery) framework by the European Commission's QUEST model. The integration of safe assets decreases the home bias in banks' sovereign debt holdings. Safe assets are pooled safe domestic bonds across the regions, alongside riskier domestic bonds. A bank balance sheet restructuring from riskier domestic assets towards safe euro area-wide assets has direct consequences for the shock stabilization. First results show that an area-wide restructuring measure leads to a GDP stabilization and lower bond prices for risky assets. Finally, Chapter 6 concludes with a summary.