The green transition of the EU economy will require substantial investment to 2030 and beyond. Estimates of green investment needs vary between institutions and are surrounded by high uncertainty, but they all point to a requirement for faster and more ambitious action. Green investment will need to be financed primarily by the private sector. While banks are expected to make a key contribution to funding the green transition, capital markets need to deepen further, especially to support innovation financing. Progress on the capital markets union would support the green transition. Public funds will be vital to complement and de-risk private green investment. Structural reforms and enhanced business conditions should be tailored to encourage firms, households and investors to step up their green investment activities.

This paper analyses how country-specific institutional quality shapes the impact of monetary policy on downside risks to GDP growth in the euro area. Using identified high-frequency shocks in a growth-at-risk framework, we show that monetary policy has a higher impact on downside risks in the short term than in the medium term. However, this result for the euro area average hides significant heterogeneity across countries. In economies with weak institutional quality, medium-term growth risks increase substantially following contractionary monetary policy shocks. In contrast, these risks remain relatively stable in countries with high institutional quality. This suggests that improvements in institutional quality could significantly enhance euro area countries’ economic resilience and support the smooth transmission of monetary policy.

We explore the interaction between labour market reforms and financial frictions. Our study combines a new cross-country reform database on labour market reforms with matched firm-bank data for nine euro area countries over the period 1999 to 2013. While we find that labour market reforms are overall effective in increasing employment, restricted access to bank credit can undo up to half of long-term employment gains at the firm-level. Entrepreneurs without sufficient access to credit cannot reap the full benefits of more flexible employment regulation.

This paper analyses the implications of corporate indebtedness for investment following large economic shocks. The empirical analysis is based on a large Orbis-iBACH firm-level data set for euro area countries from 2005 to 2018. Our results suggest that investment of high-debt firms is significantly depressed for an extended period in the aftermath of economic crises. In the four years after a negative economic shock, the cumulative loss of capital of high-debt firms is around 15% higher than that of firms with lower debt burdens. The negative impact of high debt on investment is most evident for firms in Southern and Eastern Europe and for micro firms. These findings suggest a potentially significant negative impact of increased corporate indebtedness on investment in the post-COVID-19 recovery.

This paper analyses the implications of climate change for the conduct of monetary policy in the euro area. It first investigates macroeconomic and financial risks stemming from climate change and from policies aimed at climate mitigation and adaptation, as well as the regulatory and fiscal effects of reducing carbon emissions. In this context, it assesses the need to adapt macroeconomic models and the Eurosystem/ECB staff economic projections underlying the monetary policy decisions. It further considers the implications of climate change for the conduct of monetary policy, in particular the implications for the transmission of monetary policy, the natural rate of interest and the correct identification of shocks. Model simulations using the ECB’s New Area-Wide Model (NAWM) illustrate how the interactions of climate change, financial and fiscal fragilities could significantly restrict the ability of monetary policy to respond to standard business cycle fluctuations. The paper concludes with an analysis of a set of potential monetary policy measures to address climate risks, insofar as they are in line with the ECB’s mandate. JEL Classification: E52, E58, Q54

The aim of this report is to foster a better understanding of past trends in, and drivers of, productivity growth in the countries of the European Union (EU) and of the interplay between productivity and monetary policy. To this end, a group of experts from 15 national central banks and the European Central Bank (ECB) joined forces and pooled data and expertise for more than 18 months to produce the report. Group members drew on the extensive research already conducted on productivity growth, including within the European System of Central Banks and in the context of the review of the ECB’s monetary policy strategy, and worked together to conduct new analyses.After recalling the key facts and figures, the report looks into the predominant drivers of productivity growth in firms, with a focus on technology as a key determinant of aggregate productivity dynamics. It then discusses the main factors behind resource reallocation both across incumbent firms and as a result of the entry and exit of firms. Although productivity is a real-economy phenomenon and its evolution predominantly hinges on the structural features of the economy and national policies, the report also raises the question of the extent to which, and under what circumstances, monetary policy may affect productivity. In addition, it places productivity in a broader perspective by taking into account other important structural trends that are expected to have an impact on productivity in the medium-to-long run, such as globalisation, population ageing, climate change and digitalisation. Finally, the report considers the possible impacts of the coronavirus (COVID-19) pandemic on productivity in EU countries. ...

The last review of the ECB's monetary policy strategy in 2003 followed a period of predominantly upside risks to price stability. Experience following the 2008 financial crisis has focused renewed attention on the question of how monetary and fiscal policy should best interact, in particular in an environment of structurally low interest rates and persistent downside risks to price stability. This debate has been further intensified by the economic impact of the coronavirus (COVID-19) pandemic. In the euro area, the unique architecture of a monetary union consisting of sovereign Member States, with cross-country heterogeneities and weaknesses in its overall construction, poses important challenges. Against this background, this report revisits monetary-fiscal policy interactions in the euro area from a monetary policy perspective and with a focus on the ramifications for price stability and maintaining central bank independence and credibility. The report consists of three parts. The first chapter presents a conceptual framework for thinking about monetary-fiscal policy interactions, thereby setting the stage for a discussion of specifically euro area aspects and challenges in subsequent parts of the report. In particular, it reviews the main ingredients of the pre-global financial crisis consensus on monetary-fiscal policy interactions and addresses significant new insights and refinements which have gained prominence since 2003. In doing so, the chapter distinguishes between general conceptual aspects – i.e. those aspects that pertain to an environment characterised by a single central bank and a single fiscal authority and those aspects that pertain to an environment characterised by a single central bank and many fiscal authorities (a multi-country monetary union). ...

This paper analyses the incidence and severity of sudden stops in euro area countries before and after the introduction of the ECB’s asset purchase programmes. We define sudden stops as abrupt declines in private net financial inflows, i.e. total flows adjusted for EU and IMF loans and changes in TARGET2 balances. We document that sudden stop were more frequent and more severe in euro area countries compared to other OECD economies over the period 1999–2020. We find that the susceptibility of euro area countries to severe sudden stops mainly reflects domestic fundamentals whereas there is no clear evidence of an adverse direct effect of being part of the euro area. Moreover, our econometric analysis suggests that the ECB asset purchase programmes have overall almost halved the risk of severe sudden stops in euro area countries. We find tentative evidence that this effect operates through confidence channels.

Structural policies in the euro area are of great interest for the Eurosystem, particularly as they can support the smooth functioning of the Economic and Monetary Union (EMU) and the effectiveness of monetary policy. This paper adopts a broad definition of structural policies, analysing not only the benefits of efficient labour, product and financial market regulations, but also emphasising the importance of good governance and efficient institutions that ensure high quality and impartial public services, the rule of law and the control of rent-seeking. The paper concludes that there are many opportunities for enhanced structural policies in EU and euro area countries which can yield substantial gains by boosting long-term income and employment growth and supporting social fairness, also via better and more equal opportunities. It provides empirical and model-based analyses on the impacts and the interactions of structural policies, highlighting synergies between growth and inclusiveness, while acknowledging that structural policy changes need to be country-specific to reflect national conditions and social preferences. Welldesigned structural policies would also strengthen economic resilience and convergence of Member States, bringing the euro area closer to the requirements of an optimal currency area and improving the transmission of monetary policy. The paper also discusses the political economy causes of the sluggish implementation of socially beneficial structural policies and assesses ways to deal with possible shortterm costs of reforms. JEL Classification: D60, E24, G28, H11, J08, O47, O43

This paper investigates the link between corporate debt and investment for a group of fi ve peripheral euro area countries. Using firm-level data from 2005-2014, we postulate a non-linear corporate leverage-investment relationship and derive thresholds beyond which leverage has a negative and signi ficant impact on investment. The investment sensitivity of debt increased after 2008 when financial distress intensifi ed and fi rms had a lower capacity to finance investment from internal sources of funds. Our results also suggest that even moderate levels of debt can exert a negative influence on investment for smaller firms or when pro fitability is low. JEL Classification: E22, F34, G31, G32

The euro area sovereign debt crisis has highlighted the importance of reducing public debt levels and building up sufficient fiscal buffers during normal and good times. It has also reaffirmed the need for a thorough debt sustainability analysis (DSA) to act as a warning system for national policies. This paper introduces a comprehensive DSA framework for euro area sovereigns that could be used for analysis of fiscal risks and vulnerabilities. Specifically, this framework consists of three main building blocks: (i) a deterministic DSA, which embeds debt simulations under a benchmark and various narrative shock scenarios; (ii) a stochastic DSA, providing for a probabilistic approach to debt sustainability; and (iii) other relevant indicators capturing liquidity and solvency risks. The information embedded in the three main DSA blocks can be summarised in a heat map, which can provide guidance on the overall assessment of risks to debt sustainability. This method reflects the need to have a broad-based assessment, cross-checking information and perspectives from various sources with a view to deriving a robust debt sustainability assessment. JEL Classification: E62, H62, H63, H68

This paper investigates the link between sovereign ratings and macroeconomic fundamentals for a group of euro area countries which recorded rating downgrades amid the euro area sovereign debt crisis. We apply an elaborated econometric estimation technique, based on a Bayesian ordered probit model, to understand how the decisions of rating agencies can be explained by economic developments. The estimated model re-produces historical ratings by using a small number of economic and institutional variables, which seem to effectively summarize the large number of criteria used by Moody’s, Standard & Poor’s and Fitch in their assignment of sovereign ratings. Our results suggest that the size of the downgrades observed since the start of the sovereign crisis has been broadly in line with the deterioration of economic fundamentals for most countries.

We show that the speed and type of corporate deleveraging depends on the interaction between corporate and financial sector health. Based on granular bank-firm data pertaining to small and medium-sized enterprises (SME) from five stressed and two non-stressed euro area economies, we show that “zombie” firms generally continued to lever up during the 2010–2014 period. Whereas relationships with stressed banks reduce SME leverage on average, we also show that zombie firms that are tied to weak banks in euro area periphery countries increase their indebtedness even further. Sustainable economic recovery therefore requires both: deleveraging of banks and firms.

The financial crisis affected regions in Europe in a different magnitude. This is why we examine whether regions which incorporate banks with a higher intermediation quality grow faster in "normal" times and are more resilient in "bad" ones. For this purpose, we measure the intermediation quality of a bank by estimating its profit and cost efficiency while taking the changing banking environment after the financial crisis into account. Next, we aggregate the efficiencies of all banks within a NUTS 2 region to obtain a regional proxy for financial quality in twelve European countries. Our results show that relatively more profit efficient banks foster growth in their region. The link between financial quality and growth is valid in "normal" and in "bad" times. These results provide evidence to the importance of swiftly restoring bank profitability in euro area crisis countries through addressing high non-performing loans ratios and decisive actions on bank recapitalization.

This paper examines whether European regions which incorporate banks with a higher intermediation quality grow faster and are more resilient to negative shocks than its less efficient peers. For this purpose, we measure a bank's intermediation quality by estimating its profit and cost efficiency while taking the changing banking environment after the financial crisis into account. Next, we aggregate the efficiencies of all banks within a NUTS 2 region to obtain a regional proxy for financial quality in twelve European countries. Our results show that relatively more profit efficient banks foster growth in their region. The link between financial quality and growth is valid both in the pre-crisis and post-crisis period. These results provide evidence to the importance of swiftly restoring bank profitability in euro area crisis countries through addressing high non-performing loans ratios and decisive actions on bank recapitalization.

We argue that, under certain conditions, firms consider exports as a substitute for domestic demand. Our econometric model for six euro area countries suggests domestic demand and capacity constraints as additional variables for export equations. We apply the exponential and logistic variant of a smooth transition regression model and find that domestic demand developments are relevant for short-run export dynamics particularly during more extreme stages of the business cycle. A substitutive relationship between domestic and foreign sales can most clearly be found for Spain, Portugal and Italy, providing evidence of the importance of sunk costs and hysteresis in international trade.

Traditional specifications of export equations incorporate foreign demand as a demand pull factor and the real exchange rate as a relative price variable. However, such standard export equations have failed to explain the export performance of euro area countries during the crisis period. In particular, the significant gains in export market shares in a number of vulnerable euro area crisis countries did not coincide with an appropriate improvement in price competitiveness. This paper argues that, under certain conditions, firms consider export activity as a substitute of serving domestic demand. The strength of the link between domestic demand and exports is dependent on capacity constraints. Our econometric model for six euro area countries suggests domestic demand pressure and capacity constraint restrictions as additional variables of a properly specified export equation. As an innovation to the literature, we assess the empirical significance through the logistic and the exponential variant of the nonlinear smooth transition regression model. In the first case, we differentiate between positive and negative changes in capacity utilization and in the second case between small and large changes of the same transition variable. We find that domestic demand developments are relevant for the short-run dynamics of exports when capacity utilization is low. For some countries, we also find evidence that the substitution effect of domestic demand on exports turns out to be stronger the larger is the deviation of capacity utilization from its average value over the cycle.

The housing boom that preceded the Great Recession was due to an increase in credit supply driven by looser lending constraints in the mortgage market. This view on the fundamental drivers of the boom is consistent with four empirical observations: the unprecedented rise in home prices and household debt, the stability of debt relative to house values, and the fall in mortgage rates. These facts are difficult to reconcile with the popular view that attributes the housing boom to looser borrowing constraints associated with lower collateral requirements. In fact, a slackening of collateral constraints at the peak of the lending cycle triggers a fall in home prices in our framework, providing a novel perspective on the possible origins of the bust.

In this paper we consider five euro area countries with current account and especially trade deficits during the last years which have recently improved. We argue that one reason for the improvement could be firms trying to substitute for low domestic demand by shifting sales to the export market, particularly during economic recessions. Our econometric model therefore adds domestic demand as a further variable to smooth transition regression model that tries to capture business cycle effects by capacity constraints. In four out of our five countries, we find a substitutive relationship between domestic and foreign demand during more extreme stages of the business cycle. We conclude that for these countries, during business cycle troughs as currently found, domestic demand is indeed relevant for the short-run exporting dynamics.