The post-crisis slump in Europe: a business cycle accounting analysis

Florian Gerth; Keisuke Otsu

doi:10.1515/bejm-2016-0189

Published by De Gruyter August 29, 2017

The post-crisis slump in Europe: a business cycle accounting analysis

Florian Gerth and Keisuke Otsu

From the journal The B.E. Journal of Macroeconomics

https://doi.org/10.1515/bejm-2016-0189

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Abstract

This paper analyzes the post-crisis slump in 30 European economies during the 2008Q1–2014Q4 period using the business cycle accounting (BCA) method à la [Chari, V. V., P. Kehoe, and E. McGrattan. 2007. “Business Cycle Accounting.” Econometrica 75 (3): 781–836]. We find that the deterioration in the efficiency wedge is the most important driver of the European Great Recession and that this adverse shock persists throughout our sample. Moreover, we find that countries with higher growth in nonperforming loans feature a smaller decline in efficiency wedges. These findings support the emerging literature on resource misallocation triggered by financial crises.

Keywords: business cycle accounting; European economy; Great Recession

JEL Classification: E13; E32

Acknowledgement

We are grateful to the editor, anonymous referee, Sylvain Barde, Pedro Brinca, Jagjit Chadha, Patrick Minford, Claudio Morana, Jakub Muck, and participants of the University of Kent MaGHiC PhD workshop, the 47th MMF Annual Conference, and the SCE 22nd International Conference on Computing in Economics and Finance and seminars at the University of Barcelona, RWI Essen and Keio University for their helpful comments.

A Sensitivity analysis

A.1 Government wedges

In CKM ( 2007) and BCKM ( 2016) the estimation is conducted using data of output, investment, labor and government wedges. The main reason why we use consumption data instead of the government wedge data for estimation is because for Latvia and Romania there are periods in which the government wedge turns negative due to a large trade deficit. Since we cannot take logs of negative numbers, we use the consumption data which is always positive. We also prefer using the consumption data to decompose the fluctuation in consumption in the same way as the other endogenous variables.

Technically speaking, the consumption data series can be reproduced from the linearized resource constraint up to the linearization error. Therefore, the difference in estimation results should be coming from the linearization error. When the fluctuations in government wedges and consumption are large, the linearization error might become large enough to affect the accounting results.

Figure 8 presents the simulation results for output using government wedges as an observable for countries except for Latvia and Romania.^[28] In order to compute the cross-country mean, we used the benchmark results for Latvia and Romania. The results show that using government wedges as observables increases the importance of investment wedges in accounting for the post crisis slump. The general reason behind this result is that when we use the government wedge as an observable the linearized consumption series in the model drops less than that in the data. As a result, the role of investment wedges which encourage consumption over investment is overstated. However, the quantitative impact is not substantial.

Figure 8:

Accounting result: output with ω_g observable.

A.2 Adjustment costs

In this section, we investigate the impact of investment adjustment costs on the accounting results. We follow BCKM ( 2016) and assume quadratic adjustment costs in the capital accumulation equation:

Λkt+1=it+(1−δ)kt−ϕ2(itkt−Φ)2kt,

where Φ = Λ − (1 − δ).

The impact of investment adjustment costs have been discussed in CKM ( 2007). They show that adjustment costs should systematically increase the contribution of investment wedges on output fluctuation. We find that this is true in our sample as well.

Figure 9 presents the simulation results for output from the model with investment adjustment costs.^[29] We follow CKM ( 2007) and BCKM ( 2016) and set the adjustment cost parameter ϕ for each country such that the marginal Tobin’s q is equal to 1/4. The results show that the contribution of investment wedges on the post crisis slump is indeed greater when investment adjustment cost is included in the model. Nonetheless, the efficiency wedges remain the most dominant wedge in accounting for the post crisis slump in Europe.

Figure 9:

Accounting result: output with investment adjustment cost.

B Decomposition of consumption, investment and labor

In this section, we conduct the BCA decomposition for consumption, investment and labor. Table 9 and Table 10 show that efficiency wedges contribute significantly to the drop in consumption and investment in all countries except for Malta. Table 11 shows that in Germany, Slovakia, Czech Republic, Sweden and United Kingdom labor is growing relative to the pre-crisis trend. However, there is no clear pattern regarding the contributions of each wedge to the changes in labor.

Table 9:

Country-specific post-crisis behavior: consumption.

Country	Consumption drop (%)	Wedge Contributions (%)
	2007Q4-2014Q4	ω_e	ω_g	ω_i	ω_h
Austria	15.07	82.80	−3.02	−1.30	21.52
Belgium	10.09	130.33	−23.52	6.74	−13.55
Cyprus	22.37	55.94	14.86	−49.73	78.92
Estonia	57.13	79.13	1.75	−7.38	26.50
Finland	20.37	170.67	−42.47	−1.40	−26.81
France	9.19	108.24	−7.36	−5.04	4.16
Greece	49.62	72.49	17.30	−8.83	19.04
Germany	4.44	165.61	−1.46	2.58	−66.73
Ireland	34.59	31.96	−8.02	22.27	53.78
Italy	21.65	72.36	1.65	2.13	23.86
Latvia	49.42	85.76	14.52	−5.37	5.08
Lithuania	48.36	73.91	10.31	−9.66	25.45
Luxembourg	23.29	190.07	−122.95	0.42	32.46
Malta	0.68	−2034.80	1303.64	341.63	489.53
Netherlands	21.56	84.87	−5.23	15.02	5.34
Portugal	17.98	45.64	20.57	−6.07	39.87
Slovakia	31.07	66.59	24.38	6.54	2.49
Slovenia	30.66	98.38	9.58	−14.18	6.23
Spain	31.09	38.96	18.99	1.89	40.16
Bulgaria	22.37	59.77	6.90	−49.73	3.21
Czech Republic	14.65	110.23	−1.67	3.15	−11.71
Denmark	13.51	101.29	−9.49	−9.69	17.89
Hungary	39.21	47.51	15.82	15.47	21.20
Poland	6.63	270.29	−81.39	36.03	−124.94
Romania	20.73	63.84	14.41	−19.46	41.21
Sweden	10.23	203.14	−58.48	2.49	−47.15
United Kingdom	20.49	86.34	−8.65	8.97	13.34
Iceland	41.14	38.54	26.63	0.19	34.65
Norway	6.63	435.71	−178.34	−50.27	−107.11
Switzerland	7.11	87.81	2.76	−0.61	10.03

Source: Authors calculation

Table 10:

Country-specific post-crisis behavior: investment.

Country	Investment drop (%)	Wedge Contributions (%)
	2007Q4-2014Q4	ω_e	ω_g	ω_i	ω_h
Austria	23.96	94.53	1.21	15.59	−11.33
Belgium	19.50	183.75	−24.34	−36.12	−23.29
Cyprus	100.71	14.81	36.24	67.77	−18.82
Estonia	71.28	61.26	−7.67	36.22	10.19
Finland	44.09	220.33	−101.88	6.91	−25.36
France	18.81	84.93	−21.08	35.20	0.95
Greece	122.77	38.26	14.24	31.61	15.90
Germany	9.50	140.83	3.59	5.37	−49.78
Ireland	38.99	10.09	−25.26	109.09	6.08
Italy	50.29	72.95	3.00	−5.98	30.02
Latvia	92.03	48.41	10.41	40.32	0.85
Lithuania	64.03	98.38	2.73	−10.42	9.31
Luxembourg	10.36	460.91	−596.69	286.18	−50.40
Malta	21.06	−228.06	354.70	−33.48	6.84
Netherlands	31.12	130.39	−10.70	−62.47	42.79
Portugal	53.60	30.32	34.84	12.58	22.26
Slovakia	52.89	58.69	32.89	3.05	5.36
Slovenia	85.11	16.97	26.34	57.27	−0.58
Spain	58.02	44.42	19.42	−2.64	38.80
Bulgaria	59.98	9.44	0.10	88.31	2.15
Czech Republic	24.58	126.37	−6.80	−8.14	−11.43
Denmark	25.39	20.52	−20.92	106.64	−6.24
Hungary	44.55	127.45	19.98	−82.73	35.31
Poland	27.03	38.18	17.38	61.35	−16.91
Romania	12.68	71.66	−149.86	210.68	−32.47
Sweden	18.11	228.30	−85.23	4.89	−47.96
United Kingdom	1.70	2009.76	−435.32	−1491.25	16.81
Iceland	73.15	36.36	9.26	39.94	14.43
Norway	27.03	124.18	−95.42	96.70	−25.45
Switzerland	31.25	61.11	39.75	−4.33	3.47

Table 11:

Country-specific post-crisis behavior: labor.

Country	Labor Drop (%)	Wedge Contributions (%)
	2007Q4-2014Q4	ω_e	ω_g	ω_i	ω_h
Austria	2.79	12.61	6.83	29.45	51.10
Belgium	0.76	241.59	314.66	−213.76	−242.50
Cyprus	22.37	−4.62	−5.49	67.33	42.78
Estonia	4.49	−167.56	−2.70	143.43	126.83
Finland	2.13	235.26	164.99	32.40	−332.65
France	1.66	41.34	32.97	88.26	20.11
Greece	17.11	−4.80	−24.15	46.21	82.74
Germany	−3.91	−0.62	0.53	−1.46	101.55
Ireland	17.32	−20.29	11.25	28.27	80.78
Italy	10.30	14.94	−4.42	−6.63	96.11
Latvia	1.04	−322.13	−372.15	696.82	97.47
Lithuania	2.40	−58.08	−157.96	16.86	299.18
Luxembourg	9.70	−147.87	179.68	47.89	20.31
Malta	−6.62	57.18	70.67	28.88	−56.73
Netherlands	1.62	1.96	29.78	−301.60	369.86
Portugal	9.84	8.93	−21.69	16.15	96.61
Slovakia	−0.86	−82.46	561.66	32.22	−411.43
Slovenia	4.99	−151.55	−25.80	257.10	20.25
Spain	13.53	11.71	−42.38	−3.87	134.54
Bulgaria	3.33	−113.55	−29.75	195.45	47.85
Czech Republic	−2.57	−30.17	−5.12	22.44	112.86
Denmark	2.33	−213.40	42.32	230.01	41.07
Hungary	1.74	283.94	−319.50	−554.96	690.52
Poland	0.89	−366.06	1005.75	238.79	−778.47
Romania	6.03	−50.77	−23.32	93.76	80.33
Sweden	−1.54	85.29	−264.43	−3.16	282.30
United Kingdom	−1.65	−10.18	−87.75	258.26	−60.32
Iceland	5.56	−3.21	−159.60	85.77	177.04
Norway	0.89	−897.92	925.28	741.44	−668.80
Switzerland	1.78	72.43	−5.00	−11.28	43.85

C Population weighted results

Figure 10 presents the detrended data of each country weighted by its population. It is clear that the population weighted average of each variable falls less than the benchmark simple mean of them. This is because the countries that experienced the largest economic down turn such as Greece, Estonia and Latvia are small in terms of population while those that experienced a much smaller economic down turn such as Germany and France are much larger in terms of population.

Figure 11 presents the population weighted wedges. The population weighted average efficiency and labor wedge decline less than their benchmark simple mean counterparts. Government wedges increase less in the population weighted average than in the benchmark simple mean. The interesting result is the investment wedge. The population weighted average investment wedges gradually returns to the trend level while the benchmark simple mean continues to fall. This implies that investment market distortions in large countries gradually resolved while those in smaller countries remain.

Figure 10:

Population weighted data.

Figure 11:

Population weighted computed wedges.

Figure 12 presents the population weighted average of the accounting results for output. The results show that the main reason that the population weighted average output dropped less than the benchmark simple mean is because the efficiency wedges decline less and investment wedges recover to the trend level in the population weighted results.

Figure 12:

Population weighted accounting results: output.

D Country groups

The countries in each regional group are listed in Table 12.

Table 12:

Regional country groups.

Eastern Europe	Bulgaria, Estonia, Latvia, Lithuania, Slovakia, Slovenia,
	Czech Republic, Hungary, Poland, Romania
Southern Europe	Cyprus, Greece, Italy, Portugal, Spain
Euro	Austria, Belgium, Cyprus, Estonia, Finland, France, Germany,
	Greece, Ireland, Italy, Latvia, Luxembourg, Netherlands, Portugal, Slovakia, Slovenia, Spain
Nordic Countries	Denmark, Finland, Iceland, Norway, Sweden
BeNeLux	Belgium, Luxembourg, the Netherlands
British Isles	Ireland and the United Kingdom

Source: Authors' definition

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Published Online: 2017-8-29

The post-crisis slump in Europe: a business cycle accounting analysis

Abstract

Acknowledgement

A Sensitivity analysis

A.1 Government wedges

A.2 Adjustment costs

B Decomposition of consumption, investment and labor

C Population weighted results

D Country groups

References

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