Working Paper: CEPR ID: DP2062
Authors: Duncan Maclennan; John Muellbauer; Mark Stephens
Abstract: Despite convergence pressures, differences in housing and financial market institutions across the 15 member states of the European Union are still enormous. This paper argues that they have profound effects on the responsiveness of output and inflation in the different countries to changes in short-term interest rates, as well as to asset market shocks of external origin. The economic reasoning behind this claim is set out and the institutional differences are described. The paper assesses the sometimes conflicting empirical evidence on this issue. Barriers to convergence and implications for labour market flexibility are discussed. The UK, Ireland, Finland and Sweden tend to cluster at one extreme of the relevant institutional characteristics. The paper concludes with a set of proposals for institutional reforms which would significantly reduce the tensions within EMU and the potential for instability in these economies entailed by EMU membership.
Keywords: monetary transmission; EMU; asymmetries
JEL Codes: E44; E52; E58; E63; R23
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Differences in housing and financial market institutions (G21) | Variations in output response to changes in short-term interest rates (E43) |
| Differences in housing and financial market institutions (G21) | Variations in inflation response to changes in short-term interest rates (E31) |
| Rigid financial systems (P34) | Greater output sensitivity to interest rate increases (E43) |
| Flexible financial systems (P34) | Lesser output sensitivity to interest rate increases (E43) |
| Institutional characteristics (D02) | Influence on magnitude and direction of interest rate effects on consumer expenditure (E43) |
| Institutional characteristics (D02) | Influence on magnitude and direction of interest rate effects on investments (E43) |
| Institutional characteristics (D02) | Influence on magnitude and direction of interest rate effects on government spending (E62) |
| Rising house prices (R31) | Increased consumer spending in high owner-occupation countries (D12) |
| Rising house prices (R31) | Decreased consumer spending in larger rental markets (R22) |