Linkages between the Eurozone and the South-Eastern European Countries: A VECMX Analysis

Linkages between the Eurozone and the South-Eastern European Countries: A VECMX Analysis

We assess the impact of the Eurozone’s economic policies on specific South-Eastern European countries. Since these countries are connected to the EU or the Eurozone and the economic interdependence among them is evolving, we carried out our analysis using the VECMX framework.

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The integration procedure of the South-Eastern European economies to the European Union (EU) is continuously evolving during the last decades. Some of the South-Eastern European countries are either already members of the EU or the Eurozone, or associated with the EU; while others are set to become EU members. This integration procedure implies that the EU affects the above countries in a more systematic way. It has also led to the expansion of economic transactions in the whole region. Consequently, there is a need of systematic and detailed research about the economic policies of the countries in this region, especially in our days when the current financial and debt crisis in the Eurozone is at stake. For instance, Greece, which is a Eurozone member since 2001, is in deep recession with high sovereign debt, and having signed the Memoranda I and II with the ECB-EU-IMF, is in fiscal contraction and faces high unemployment. Also, the emerging economies of the South- Eastern Europe have relatively high current account deficits and are more vulnerable to the deterioration of the international economy, since they have been negatively affected by the reduction of external demand and the increase in the cost of borrowing from abroad.

In this study we attempt to investigate the monetary transmission mechanism of the Eurozone’s monetary policy for seven countries of South-Eastern Europe, namely Bulgaria, Croatia, Cyprus, Greece, Romania, Slovenia and Turkey. Also, we explore the way that foreign macroeconomic variables affect their domestic counterparts, for each of the above countries. Especially for the transition economies (Bulgaria, Croatia, Romania and Slovenia) this analysis will allow us (a) to understand how fast, and to what extent, a change in the central bank’s instruments modifies domestic variables, such as inflation, and (b) to evaluate whether monetary transmission operates differently in the transition economies. In general, the monetary policy transmission mechanism in Central and Eastern Europe has been analysed by Coricelli, Égert and MacDonald (2006). These authors studied this mechanism through four channels: (i) interest rate channel, (ii) exchange rate channel, (iii) asset price channel, and (iv) broad lending channel.

The literature about monetary policy transmission mechanism is quite large and extending. In general, the interest rate pass-through is usually investigated using an error correction model (ECM) framework. Regarding the transition countries of the Central and Eastern Europe, several researchers have studied the asymmetry of the adjustment process, in relation to the Eurozone countries, with mixed results (Opiela, 1999; Crespo-Cuaresma, Égert and Reininger, 2004; Horváth, Krekó and Naszódi, 2004; Sander and Kleimeier, 2004; Égert Crespo-Cuaresma and Reininger, 2006). Additionally, a number of researchers have studied the long-run pass through. Their results indicate that both the contemporaneous and long-run pass-through increase over time, while the mean adjustment lag to full pass-through decreases, as more recent data have been used (Crespo-Cuaresma, Égert and Reininger, 2004; Horváth, Krekó and Naszódi, 2004; Sander and Kleimeier, 2004). Also, there is a number of studies that investigate the exchange-rate pass-through in the transition economies, using mainly vector autoregressive (VAR) and vector error-correction (VECM) models (see, for instance, Darvas, 2001; Mihaljek and Klau, 2001; Coricelli, Jazbec and Masten, 2003; Gueorguiev, 2003; Kara et al., 2005; Korhonen and Wachtel, 2005).

Since the economies of South-Eastern Europe are quite interdependent and influenced, as well, by the the EU and the Eurozone, models that have been used for studying the domestic economies are not well-suited, since they do not take into account the way economies react to economic and financial interdependencies. In the last decades, the use of VARs and the subsequent cointegration analysis have resulted in long-run relations between various variables in the same economy, as suggested by economic theory. However, many long-run relations in one country may be influenced and affected by variables from other regions. One of the problems with the VAR methodology is that it works with a limited number of variables. But in order to incorporate a reasonable number of variables to account for global effects, large dimensionally system are required. A very important step in this direction is the development of Global VAR (GVAR) modelling developed by Pesaran, Schuermann and Weiner (2004, henceforth PSW), which facilitated the study of international linkages. This methodology has been used to examine the interdependencies of economies worldwide. More specifically, it was used to investigate the changing degree of the dominance of the USA economy and its effect on other regions (Dées and Sain-Guilhem, 2009), the analysis of the Swiss economy (Assenmacher-Wesche and Pesaran, 2009), the role of China and its increased influence around the world (Feldkircher and Korhonen, 2012), the linkages in the euro area (Dées, di Mauro, Pesaran and Smith, 2005), world trade flows (Bussiére, Chudik and Sestieri, 2012), and regional financial effects (Galesi and Sgherri, 2009). 

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