Study on the impact of policy measures on the economy

Italy to remain in eurozone according to inflation expectations

The turmoil surrounding the economic situation in Italy has returned in recent weeks. Based on inflation expectations, however, Italian consumers intend to remain in the eurozone. Inflation expectations would indeed rise if the country were to leave the eurozone, though the findings show that inflation expectations actually fall during times of concern over the eurozone’s future. This points to an internal adjustment mechanism within the eurozone. This is one of the conclusions reached by Beau Soederhuizen in his dissertation titled “Empirical studies on (un)conventional policies and macroeconomic adjustment during the crisis”, for which he will receive his doctorate from Nyenrode Business Universiteit on 11 June 2018. At age of 26, Soederhuizen is the youngest person ever to earn a PhD from the university.

Soederhuizen’s dissertation consists of four studies which focus exclusively on the effects of policy measures relating to the financial crisis. The first of these studies investigated in 13 EMU countries whether it was possible to predict if a country would leave the eurozone based on the inflation expectations of consumers. Soederhuizen explains: “Consumers are aware that reforms are economically painful, but such reforms are simply necessary for a country to get back on its feet in economic terms. Consumers see that leaving the Eurozone does not ease the pain, but instead has the opposite effect.”

Effective budgetary policy

By lowering the policy rate, central banks hope to stimulate spending among consumers. According to the second study in the dissertation, when this lowering is not successful, a country’s budgetary policy may offer a solution. Soederhuizen: “If you add policy measures such as government consumption and investments to your crisis toolbox, this can help the economy to get back on track. My research reveals that the effect of this is significantly greater when interest rates are low compared to when they are high. A central bank has fewer policy options when rates are low, so it is essentially an interplay between government policy and the policies of central banks.” The results of the research support the plea of various central bankers to give governments’ budgetary policies a more important role in stabilizing the economy, provided that the government debt remains sustainable and allows for this enhanced role.

Liquidity provision by central banks

The European Central Bank can also play an important role in stabilizing an economy. The third study of Soederhuizen’s dissertation examines the effects of central banks’ liquidity provisions towards banks. The study shows that financial instability among banks leads to a greater demand for funding from the European Central Bank. Soederhuizen comments on the effects this has: “In the short term, a bank’s stability does not increase with this type of liquidity provision, but in fact decreases when we look at market responses. It does not create confidence when banks need additional funding, which can be seen as a sign of distress. Nevertheless, the effect on the stability of banks can be positive in the long term and monetary policy measures have a direct and significant impact on the size and composition of the balance sheets of individual countries’ central banks.”

Impact of monetary policy

In the fourth study, Soederhuizen examined whether the balance sheets of central banks of different countries or regions within a currency union are in sync. To do so, he compared the developments of the balance sheets of the European Central Bank (EA) and the Federal Reserve System (US) with the balance sheets of central banks in each country (EA) or region (US). In the US, the balance sheets of the Federal Reserve System and the regional central banks were found to be in sync. This gives them greater predictability than in the eurozone, where the balance sheets are not synchronized. According to Soederhuizen, this means that in the US, such synchronicity can strengthen the impact of monetary policy on individual balance sheets. In the EA, asymmetries in balance sheets may complicate policy because each measure can have a different impact in each member state.

Still, Soederhuizen argues that it is not necessary to instantly draw negative conclusions from this in the EA: “Because not all European countries’ balance sheets respond the same way to changes in the balance sheet of the European Central Bank, they don’t inherently have to affect one another negatively either. The overall effects are limited because they average out. As a result, other EA countries can absorb the potential ‘blows’ that might strike in Italy, without immediately falling victim to these themselves.”

The summary of Beau Soederhuizen’s dissertation can be downloaded in both Dutch and English here.