Fiscal standards for Europe

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The European Union should abandon the fiscal rules intended to put constraints on national budgetary policies in favour of fiscal standards – qualitative prescriptions that leave room for judgment together with a process to decide whether the standards are met.

That is the central conclusion of a new research report by Olivier Blanchard (Peterson Institute), Alvaro Leandro (CaixaBank Research) and Jeromin Zettelmeyer (International Monetary Fund). The authors note that their proposals would mark a major departure from the status quo, requiring Treaty change.

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Exporting pollution

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Multinational firms headquartered in countries with strict environmental policies choose to conduct their polluting activities in foreign countries with relatively weaker policies. These effects are stronger for firms in pollution-intensive industries and firms with poor corporate governance. But while firms based in countries with strict policies are more likely to export pollution abroad, they nevertheless produce fewer overall carbon emissions globally.

These are among the findings of a new research report by Itzhak Ben-David (Ohio State University, Stefanie Kleimeier (Maastricht University) and Michael Viehs (University of Oxford). Their results highlight the importance of collective action to combat climate change given the global scale of many firms’ operations.

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Rising UK house prices

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The big rise in UK house prices relative to incomes between 1985 and 2018 can be more than accounted for by the substantial decline in real risk-free interest rates over the period. This is slightly offset by net increases in home-ownership costs from higher rates of tax.

These are the findings of a new research report by David Miles of Imperial College London and Victoria Monro of the Bank of England. Their analysis predicts that a 1% sustained increase in index-linked gilt yields from current rates could ultimately result in a fall in real house prices of around 20%.

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Law, guns and money in Brazil

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This paper studies the effects of legislation in Brazil that banned the right- to-carry guns and provided for a voter referendum regarding whether to ban the sale of all firearms. Using a regression discontinuity design, I find that gun-related homicides decreased by 12.2 percent, with the reduction especially pronounced in high-crime areas and among black males. There is no evidence of substitution effect as non-gun-related homicides were not affected. Analysis of the subsequent voter referendum, which was defeated by a wide margin, shows stronger support for the complete weapons ban in the areas more affected by gun violence.

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European’s banks’ susceptibility to loan losses

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We analyze the determinants of coverage ratios and their components (NPLs and loss loan reserves) in a large sample of European banks. We find that bank-specific factors, and in particular credit risk variables including forward-looking indicators, matter the most. We also uncover that coverage ratios do not adjust sufficiently when asset quality deteriorates but that high-NPL banks tend to be relatively better covered. At the country level, specific macroprudential levers as well as developing NPL secondary markets enhance bank coverage policy. Our findings emphasize the importance of micro prudential oversight and call for more stringent macro policies in high-NPL countries.

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Hot climates and cold economies

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We study the link between temperature and economic development at the sub-national level, employing cross-sectional data from two distinct sources. In contrast to the existing cross-country literature on the temperature-income relationship, our setting allows for the inclusion of country fixed effects. Once accounting for country fixed effects, we do not find a statistically robust relationship between regional temperature and three different measures of regional economic development (per capita GDP, nightlights and gross cell production). We also test whether temperature is non-linearly related to regional income (with hotter regions being potentially particularly prone to adverse effects of temperature on income) but find no systematic evidence in favor of such a relationship. Finally, we examine whether the effect of temperature on economic development is especially pronounced in poorer regions (e.g., due to weaker adaptation). Again, there is no statistically robust evidence for such a link.

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Green Deal policies could raise emissions

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The Market Stability Reserve (MSR), implemented in 2018 to complement the EU emission trading system (EU ETS), is designed such that the supply of allowances responds endogenously to demand. We show that an endogenous cap such as the MSR produces a Green Paradox. Abatement policies announced early but realized in the future are counter-effective because of the MSR: they increase cumulative emissions. We present the mechanisms in a two-period model, and then provide quantitative evidence of our result for an annual model disciplined on the price rise in the EU ETS that followed the introduction of the MSR. Our results point to the need for better coordination between different policies, such as the ‘European Green Deal’. We conclude with suggestions to improve the workings of an endogenous cap, ahead of the MSR review scheduled for 2021.

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Smart hedging against carbon leakage

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Policy makers in the EU and elsewhere are concerned that unilateral pricing of the carbon externality induces carbon leakage through relocation of emission-intensive and trade-exposed production to other regions. A common measure to mitigate such leakage is to combine an emission trading system with output-based allocation (OBA) of allowances where the latter works as an implicit production subsidy to regulated industries. We show analytically that it is optimal to impose in addition a consumption tax on the OBA goods (i.e., goods that are entitled to OBA) at a rate which is equivalent in value to the OBA subsidy rate. The explanation is that the consumption tax alleviates excessive consumption of the OBA goods, which is a distortionary effect of introducing output-based allocation. Using a multi-region multi-sector computable general equilibrium model calibrated to empirical data, we quantify the welfare gains for the EU of imposing such a consumption tax on top of its existing emission trading system with OBA. We run Monte Carlo simulations to account for uncertain leakage exposure of goods entitled to OBA. The consumption tax increases welfare whether the goods are highly exposed to leakage or not, and hence can be regarded as smart hedging against carbon leakage.

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