Claudia M. Buch, Manuel Buchholz, Alexander Lipponer, Esteban Prieto. Unit labor cost adjustments since the crisis in GIIPS vs. BELL countries: The role of central bank liquidity and rescue packages

Unit labor cost adjustments since the crisis in GIIPS vs.
BELL countries: The role of central bank liquidity and
rescue packages
Claudia M. Buch 1
Manuel Buchholz 2
Alexander Lipponer 1
Esteban Prieto 1
1
Deutsche Bundesbank
2
Halle Institute for Economic Research (IWH)
Open Seminar
Eesti Pank
Feb 19, 2015
The views expressed in the presentation are those of the authors and do not necessarily reﬂect the views
of the Deutsche Bundesbank or its staﬀ.
Buch, Buchholz, Lipponer, Prieto ULC adjustments GIIPS vs. BELL Feb 19, 2015 1 / 42

Motivation - Sudden stops in (private) capital flows during
the recent crisis in BELL countries
-2024
2000q1 2004q1 2008q1 2012q1
Quarter
BG
-.4-.20.2.4.6
2000q1 2004q1 2008q1 2012q1
Quarter
EE
-1-.50.511.5
2000q1 2004q1 2008q1 2012q1
Quarter
LT
-1-.50.511.5
2000q1 2004q1 2008q1 2012q1
Quarter
LV
Net private capital inflows (EUR bn.)
Data source: Eurostat. Net private capital inflows are defined as total net capital inflows according to financial
account. No adjustments for official rescue programs. Vertical red line indicates sudden stop period. Country
legend: BG Bulgaria; EE Estonia, LT Lithuania; LV Latvia.

Motivation - Sudden stops in (private) capital flows during
the recent crisis in GIIPS countries
-20-100102030
2000q1 2004q1 2008q1 2012q1
Quarter
EL
-150-100-50050
2000q1 2004q1 2008q1 2012q1
Quarter
ES
-50050
2000q1 2004q1 2008q1 2012q1
Quarter
IE
-100-50050100
2000q1 2004q1 2008q1 2012q1
Quarter
IT
-30-20-10010
2000q1 2004q1 2008q1 2012q1
Quarter
PT
Net private capital inflows (EUR bn.)
Data source: Eurostat and Eurocrisismonitor.com. Net private capital inflows are defined as total net capital
inflows according to financial account minus increase in Target2 liabilities (data from Eurocrisismonitor.com).
Vertical red line indicates sudden stop period. No adjustments for official rescue programs. Country legend: EL
Greece, ES Spain; IE Ireland; IT Italy; PT Portugal.

Motivation
GIIPS and the Eastern European BELL countries (Bulgaria, Estonia, Latvia,
Lithuania) experienced a sudden stop in private capital ﬂows during the
recent crisis.
Historically, the resulting adjustment pressure due to a sudden stop often
made countries devalue their currency; however, GIIPS countries were
members of currency union and each of the BELL countries kept the peg to
the Euro throughout the crisis.
Adjustment has taken place via internal devaluation, which is e.g. visible in
the development of unit labor cost (ULC) since the crisis (see e.g. Staehr,
2012 (Baltics), Blanchard et al., 2013 (Latvia)).
There are notable diﬀerences between the adjustment paths of GIIPS and
BELL countries.

Adjustment in ULC since sudden stop (by country)
0510152025
ULCdependentemployees(%ofpre-crisis)
0 5 10 15 20 25
Quarter since sudden stop
BG EE EL ES IE
IT LT LV PT
Data source: Eurostat. Variable is deﬁned in terms of adjustment, i.e. an increase (decrease) corresponds to a
reduction (increase) in ULC. Country legend: BG Bulgaria; EE Estonia, EL Greece, ES Spain; IE Ireland; IT
Italy; LT Lithuania; LV Latvia; PT Portugal.

Adjustment in ULC since sudden stop (GIIPS vs. BELL)
05101520
ULCdependentemployees(%ofpre-crisis)
0 5 10 15 20 25
GIIPS BELL
Data source: Eurostat. Variable is deﬁned in terms of adjustment, i.e. an increase (decrease) corresponds to a
reduction (increase) in ULC. Country legend: BG Bulgaria; EE Estonia, EL Greece, ES Spain; IE Ireland; IT
Italy; LT Lithuania; LV Latvia; PT Portugal.

Table of contents
1 Introduction
Motivation
Research question, related literature, main contribution
2 Aggregate analysis
Empirical specification
Estimation results
3 Sectoral analysis
Refining the empirics
Sectoral ULC
Dependence on external finance
The effect of currency union membership
Estimation results
The role of central bank liquidity
Estimation results
Robustness
Rescue programs and other variables
Estimation results
4 Concluding remarks

Research questions
Is there a (significant) difference between GIIPS and BELL countries
regarding the adjustment to recent sudden stops?
If so, is this difference related to membership in the currency union (Euro
Area)?
Identification issue: separate country-specific factors (e.g. labor market
flexibility, openness) from Euro Area membership.
Sectoral data will prove useful in this respect.
Given that the differences are not linked to currency per se (BELL pegged):
What is the role of access to liquidity provided by the ECB and rescue
packages?

Existing literature on economic adjustment since the crisis
Generally, our work relates to the literature on sudden stops and
macroeconomic adjustment (e.g. Calvo, 1998, Calvo and Mendoza, 1996,
2000).
A couple of papers with focus on EA have recently emerged.
Lindner (2011), Gros and Alcidi (2013), Hansson and Randveer (2013)
give an comprehensive overview on the diﬀerences in the adjustment paths in
GIIPS and Baltic/BELL countries.
consider key economic variables such as GDP, the current account,
consumption, and exports.
discuss the role of access to Eurosystem liquidity and rescue packages.
Tressel and Wang (2014)
argue that adjustment in current accounts in GIIPS countries partly due to
structural but mainly cyclical factors.
Kang and Shambaugh (2014)
directly compare GIIPS and Baltic countries.
ﬁnd that unit labor cost adjustment can to some extent be attributed to
productivity gains but was mainly due to falling employment.

Main contribution
We base the analysis of the adjustment in ULC on sectoral data.
In particular, nominal and real unit labor costs are considered.
As well as their components: (real/nominal) wages, prices, labor productivity.
We assume that adjustment pressure should be higher in sectors which
depend more strongly on external finance.
Our empirical specification allows disentangling the effect of Euro Area
membership from country-specific (demand) factors as well as sectoral shocks.
We relate the difference due to Euro Area membership to enhanced liquidity
provision by the ECB during the crisis (reflected in the built up of
comparatively large Target2 imbalances) and financial assistance/rescue
packages during the crisis.

Table of contents
1 Introduction
Motivation
Estimation results
3 Sectoral analysis
Sectoral ULC
Estimation results
Estimation results
Robustness
Estimation results

Empirical specification: Adjustment in aggregate ULC -
GIIPS dummy
To quantify the difference in the adjustment process in GIIPS compared to
BELL countries, we use the following specification:
ULC-Adjustit = αi + αt + γt[Dt × DGIIPS] + εit (1)
ULC-Adjustit: percentage change in the unit labor costs since the sudden
stop period relative to pre-sudden-stop level. Note that the sign is reverted
such that positive values in adjustment reflect a reduction in unit labor costs.
Country-specific sudden stop periods (last quarter before sudden stop)
EL: 2007q4; IE: 2008q1; IT: 2011q2; PT: 2010q1; ES: 2011q2
BG: 2008q4; EE: 2008q3; LV: 2008q3; LT: 2008q3
DGIIPS: GIIPS dummy
Dt: dummy indicating a specific quarter since the sudden stop
γt: captures difference in adjustment between GIIPS and BELL countries

Estimation results: Adjustment in aggregate ULC - GIIPS
dummy
-20-1001020
0 5 10 15 20
95% confidence bands Coefficient
Note: Coeﬃcient is γt from equation (1). Dependent variable is deﬁned in terms of adjustment, i.e. an
increase (decrease) corresponds to a reduction (increase) in ULC.

Table of contents
1 Introduction
Motivation
Estimation results
3 Sectoral analysis
Sectoral ULC
Estimation results
Estimation results
Robustness
Estimation results

Refining the empirics - Ingredient I: Sectoral (R)ULC
Identification issue: how to separate currency union membership from sector
and country-specific factors and shocks?
Sectoral data can prove useful in this respect.
We use data from Eurostat on 9 sectors based on the NACE (Revision 2)
classification.
The sample period spans 2007q4 to 2013q3 with country specific sudden stop
periods.
The (nominal) ULC in sector k of country i are computed using sectoral data
on total compensation for employees and real gross value added (GVA).
ULCik =
LaborCostik
LaborProductivityik
=
TotalCompensationik
TotalHoursWorkedik
RealGVAik
TotalHoursWorkedik
=
TotalCompensationik
RealGVAik
Real unit labor costs (RULC) are given by:
RULCik = ULCik/Pik =
TotalCompensationik
NominalGVAik
Where Pik is the sectoral price deflator.

Sectoral (R)ULC - Components
ULC can be multiplied by the ratio of total employment to dependent
employees to account for the number of self-employed people (see, e.g.,
Tressel and Wang, 2014):
ULCadj,ik = ULCik ×
TotalEmployment (pers.)ik
TotalDepEmployees (pers.)ik
Applying log diﬀerences, (approximate) percentage changes in ULC can be
decomposed into the following components:
%∆ULCadj,ik ≈ %∆RULCik + %∆Pik
= %∆RealWageik − %∆LaborProductivityik + %∆Pik
Thus, in addition to nominal and real ULC, we investigate adjustment in real
and nominal wages, sectoral price deﬂators and labor productivity.

Refining the empirics - Ingredient II: Dependence on
external finance (DEF)
Rationale: adjustment pressure after sudden stops is likely to be higher in
sectors which are more dependent on external finance.
Idea: measure for dependence on external finance (DEF) in the spirit of Rajan
and Zingales (1998). Link to capital flows: Prasad et al. (2007).
However: no such measure is available for the NACE classification on the
level of aggregation given in our data.
We propose two measures for sectoral dependence on external finance (DEF):
The aggregate growth rate of MFI loans in given sector pre crisis
2003q1-2008q3 (Source: ECB SDW). Only variation across sectors not
countries.
The fraction of firms in need for external loan finance pre-crisis (in 2007)
taken from the “Access to finance survey” conducted by Eurostat. Variation
across sectors and countries. However, smaller sample with fewer countries.

Dependence on external ﬁnance: pre-sudden stop MFI loan
growth
050100150
SectoralMFIloans(agg.growthratein%,2003q1-2008q3)
1 2 3 4 5 6 8 9 10 11
Sector legend: 1 Agriculture; 2 Industry; 3 Manufacturing; 4 Construction; 5 Trade; 6 Information; 7 Financial
(no data); 8 Real Estate; 9 Science; 10 Public Admin; 11 Arts

Adjustment in sectoral ULC: High vs. low DEF for GIIPS
and BELL
-4-2024
ULC(%ofpre-crisis)
0 5 10 15 20
GIIPS
-4-2024
ULC(%ofpre-crisis)
0 5 10 15 20
BELL
DEF: low DEF: high
Note: time-varying sector and country fixed effects partialled out. Dependence on external finance (DEF)
measure is based on pre-sudden stop MFI loan growth. Variable is defined in terms of adjustment, i.e. an

Adjustment in sectoral RULC: High vs. low DEF for GIIPS
and BELL
-20-10010
Realunitlaborcost(%ofpre-crisis)
0 5 10 15 20
GIIPS
-20-10010
Realunitlaborcost(%ofpre-crisis)
0 5 10 15 20
BELL
DEF: low DEF: high
Note: time-varying sector and country fixed effects partialled out. Dependence on external finance (DEF)
measure is based on pre-sudden stop MFI loan growth. Variable is defined in terms of adjustment, i.e. an

Table of contents
1 Introduction
Motivation
Estimation results
3 Sectoral analysis
Sectoral ULC
Estimation results
Estimation results
Robustness
Estimation results

Empirical specification: Adjustment in sectoral ULC - The
effect of currency union membership
To identify the impact of currency union membership on adjustment, we use
the following specification:
ULC-Adjustikt = αkτ + αiτ + αit + αkt + βDEFik
+ γt [Dt × DEFik × DGIIPS] + εit (2)
k: sector; t: quarter since sudden stop; τ: actual quarter.
The parameter γt captures the differential effect of currency union
membership on adjustment given a higher sectoral dependence on
external finance:
γt =
∆ULC-Adjustik,t−t0
∆DGIIPS
DEF=d+1
−
∆ULC-Adjustik,t−t0
∆DGIIPS
DEF=d
The specification controls for i) time-varying country-specific (αit) and ii)
time-varying sector-specific (αkt) effects.
Standard errors are clustered at the country-sector level.

Estimation results: Adjustment in sectoral ULC - The
-20-10010
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
Note: DEF measure is based on pre-sudden stop MFI loan growth. Coeﬃcient is γt from equation (2).
Dependent variable is deﬁned in terms of adjustment, i.e. an increase (decrease) corresponds to a reduction
(increase) in ULC.

Estimation results: Adjustment in sectoral RULC - The
-40-30-20-100
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
(increase) in RULC.

Estimation results: Adjustment in real wages - The eﬀect
of currency union membership
-60-40-20020
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
(increase) in real wages.

Estimation results: Adjustment in nominal wages - The
-10-505
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
(increase) in nominal wages.

Estimation results: Adjustment in labor productivity - The
-20-1001020
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

Estimation results: Adjustment in prices - The eﬀect of
currency union membership
-1001020
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
(increase) in prices.

Table of contents
1 Introduction
Motivation
Estimation results
3 Sectoral analysis
Sectoral ULC
Estimation results
Estimation results
Robustness
Estimation results

The effect of currency union membership and the role of
central bank liquidity
The estimated parameters measure the effect of being a GIIPS as opposed to
a BELL country beyond any impact of country-specific or industry-specific
demand factors or any other shocks in these dimensions.
We can therefore plausibly argue that the remaining effect has to be due to
another difference between BELL and GIIPS countries, which is the
membership in the Euro Area.
This effect does not capture a difference in currencies as the BELL countries
pegged their currency to the Euro and kept the peg throughout the observed
period. The relevant difference is rather one of access to central bank
liquidity.
Data on Target2 balances provide us with an adequate measure when and
to which extent banks in the Euro periphery have drawn on central bank
credit to substitute for dried up private capital inflows.

The role of central bank liquidity: Target2 balances
-50005001000
Target2balances(EURbn.)
2008q1 2009q1 2010q1 2011q1 2012q1 2013q1 2014q1
quarter
DE EL ES
IE IT PT
Source: Eurocrisismonitor.com

Empirical specification: Adjustment in sectoral ULC - The
role of central bank liquidity
In order to relate the effect to enhanced liquidity provided by the ECB, we
introduce Target2 liabilities (relative to GDP) into the specification:
ULC-Adjustikt = αkτ + αiτ + αit + αkt + βDEFik
+ γt [Dt × DEFik × Target2it] + εit (3)
Data on Target2 balances is from the Deutsche Bundesbank.
Data on Target2 balances is also made available on the website
Eurocrisismonitor.com run by the Institute of Empirical Economic Research
of Osnabrück University (Steinkamp/Westermann).

Estimation results: Adjustment in sectoral ULC - The role
of central bank liquidity
-10-50510
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19
(increase) in ULC.

Estimation results: Adjustment in sectoral RULC - The role
of central bank liquidity
-30-20-1001020
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19
(increase) in RULC.

Table of contents
1 Introduction
Motivation
Estimation results
3 Sectoral analysis
Sectoral ULC
Estimation results
Estimation results
Robustness
Estimation results

Robustness: Rescue programs and other variables
International rescue programs, inflation differentials, and devaluation
expectations in BELL countries might systematically affect adjustment
(conditional on DEF).
Is the effect of currency union membership robust to inclusion of these
variables?
To answer this question, we use a specification with constant γ:
ULC-Adjustikt = αkτ + αiτ + αit + αkt + β1DEFik
+ DEFik × [γDGIIPS + β2 xit] + εit (4)
xit reflects included control variables.
The parameter γ captures the average differential effect of currency union
membership over the whole estimation period.
Equivalently, to check robustness for the role of central bank liquidity:
ULC-Adjustikt = αkτ + αiτ + αit + αkt + β1DEFik
+ DEFik × [γTarget2it + β2 xit] + εit (5)

Estimation results: Robustness ULC - The effect of
Dependent variable:
ULC adjustment (% of pre-crisis)
(1) (2) (3) (4) (5)
DEF x REER -2.733*** -2.960**
(1.035) (1.226)
DEF x NEER 1.633 1.081
(1.502) (1.365)
DEF x 3M-Fwd. Exch. Rate -0.729 0.019
(1.051) (0.886)
DEF x RescueProgram/GDP -0.444*** -0.468***
(0.130) (0.138)
DEF x DGIIPS -4.048 0.199 -4.020 -4.849 -0.613
(4.723) (4.087) (4.705) (4.609) (3.754)
Country-time FE x x x x x
Sector-time FE x x x x x
Obs 1,449 1,395 1,449 1,449 1,395
R-squared 0.59 0.61 0.59 0.59 0.62
Note: DEF measure is based on pre-sudden stop MFI loan growth. Cluster-robust SE at country-sector level.
∗∗∗
, ∗∗
, ∗
denotes significance at the 1%, 5%, and 10% level. Dependent variable is defined in terms of
adjustment, i.e. an increase (decrease) corresponds to a reduction (increase) in ULC.

Estimation results: Robustness ULC - The role of central
bank liquidity
Dependent variable:
ULC adjustment (% of pre-crisis)
(1) (2) (3) (4) (5)
DEF x REER -3.197** -3.352**
(1.327) (1.581)
DEF x NEER 1.631 0.748
(1.562) (1.573)
DEF x 3M-Fwd. Exch. Rate -0.316 -0.335
(0.354) (0.318)
DEF x RescueProgram/GDP -5.754*** -5.952***
(1.684) (1.779)
DEF x Target2Liab/GDP -0.680 2.273 -0.651 -1.046 1.978
(2.010) (1.473) (1.996) (2.010) (1.424)
Obs 1,395 1,395 1,395 1,395 1,395
R-squared 0.57 0.62 0.57 0.58 0.63
∗∗∗
, ∗∗
, ∗
adjustment, i.e. an increase (decrease) corresponds to a reduction (increase) in ULC. Explanatory variables are
standardized (zero mean, unit standard deviation).

Estimation results: Robustness RULC - The eﬀect of
Dependent variable:
RULC adjustment (% of pre-crisis)
(1) (2) (3) (4) (5)
DEF x REER -0.096 0.183
(1.530) (1.660)
DEF x NEER 1.294 1.433
(1.829) (1.837)
(1.997) (2.333)
DEF x RescueProgram/GDP 0.067 0.072
(0.216) (0.227)
DEF x DGIIPS -16.024** -16.549** -15.941** -15.944*** -16.253**
(6.145) (7.513) (6.100) (5.975) (7.120)
Obs 1,449 1,395 1,449 1,449 1,395
R-squared 0.59 0.60 0.59 0.59 0.60
∗∗∗
, ∗∗
, ∗
adjustment, i.e. an increase (decrease) corresponds to a reduction (increase) in RULC.

Estimation results: Robustness RULC - The role of central
bank liquidity
Dependent variable:
RULC adjustment (% of pre-crisis)
(1) (2) (3) (4) (5)
DEF x REER -0.907 -0.774
(1.530) (1.588)
DEF x NEER 2.922* 3.099
(1.656) (1.866)
(0.426) (0.404)
DEF x RescueProgram/GDP 2.106 2.172
(2.566) (2.661)
DEF x Target2Liab/GDP -8.632*** -9.818** -8.611*** -8.624*** -9.816**
(3.246) (4.187) (3.238) (3.146) (4.080)
Obs 1,368 1,368 1,368 1,368 1,368
R-squared 0.62 0.62 0.62 0.62 0.63
∗∗∗
, ∗∗
, ∗
adjustment, i.e. an increase (decrease) corresponds to a reduction (increase) in RULC. Explanatory variables
are standardized (zero mean, unit standard deviation).

Concluding remarks
We identify the differential effect of currency union membership on
adjustment in nominal and real sectoral unit labor to a sudden stop in private
capital flows.
To shut down the currency devaluation channel, the empirical specification
directly compares GIIPS and BELL countries. In addition, the sectoral
analysis allows separating the effect from any country and sector specific
factors/shocks.
With respect to the effect of currency union membership on adjustment in
real unit labor costs (RULC), we find that
it is negative (i.e. unit labor costs reduced by less) for most periods, which
points towards a slowdown effect.
it is economically significant: up to 25% lower (cumulative) adjustment in
some periods (per one std. dev. higher DEF measure).
it is conditional on higher sectoral dependence on external finance, which is in
line with economic reasoning.
the confidence bands are rather wide in the flexible specification, but it is
highly statistically significant in simpler specification.
it is robust to inclusion of other relevant variables such as the amount of
EU/IMF rescue funds.

Concluding remarks
We find evidence that this effect goes indeed beyond the common currency
as it can robustly be related to national central banks’ Target2 liabilities,
which reflect to which extent banks in the Euro periphery have substituted
dried up private capital inflows with central bank liquidity.
However, the effect of currency union membership on adjustment appears to
be less obvious for nominal unit labor cost and labor productivity and does
not translate to sectoral price deflators.
Policy implication: General role of currency union in adjustment process after
sudden stop?

Appendix: Estimation results: Adjustment in ULC - The
effect of currency union membership - Alternative DEF
measure
-60-40-20020
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
Note: DEF measure is based on proportion of firms in need for (loan) finance in 2007.

Appendix: Estimation results: Adjustment in RULC - The
eﬀect of currency union membership - Alternative DEF
measure
-80-60-40-20020
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

Appendix: Estimation results: Adjustment in ULC - The
role of central bank liquidity - Alternative DEF measure
-30-20-10010
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19

Appendix: Estimation results: Adjustment in RULC - The
role of central bank liquidity - Alternative DEF measure
-60-40-20020
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19

Appendix: Estimation results: Adjustment in real wages -
-40-2002040
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19
Note: DEF measure is based on pre-sudden stop MFI loan growth.

Appendix: Estimation results: Adjustment in nominal
wages - The role of central bank liquidity
-6-4-202
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19

Appendix: Estimation results: Adjustment in labor
productivity - The role of central bank liquidity
-10-5051015
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19

Appendix: Estimation results: Adjustment in prices - The
role of central bank liquidity
-10-5051015
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19

Appendix: How to interpret Target2 balances?
Brought to attention by Sinn and Wollmershäuser (2011). In particular in the
beginning debate on how to correctly interpret Target2 balances (Sinn and
Wollmershäuser, 2011, 2012, Wheelan, 2011, Buiter et al. 2011). To a certain
extent, views have recently converged.
Target2 balances reﬂect asymmetric liquidity needs of banks across Euro Area
countries (see, e.g., Blinseil and König, 2011).
These needs are encountered by enhanced liquidity provision by the ECB (full
allotment policy, reduced collateral standards).
They are a monitor for malfunctioning of private capital markets in Europe
and thus a crisis indicator (see website Eurocrisismonitor.com by
Steinkamp/Westermann, Ulbrich and Lipponer, 2012).
Peculiarities: Oﬃcial rescue packages settled via Target 2 reduce liabilities:
however, not necessarily a sign of relaxation of crisis.
⇒ adjust Target2 balances

Appendix: Target2 balances in the Balance of Payments
and sudden stops in private capital flows
Sudden increase in Target2 liabilites (e.g. structural break) can be interpreted
as a sudden stop in private capital flows (see, e.g., Tornell and Westermann,
2011, Merler and Pisany-Ferry, 2012).
Balance of Payments, Financial Account (simplified): TotalCapitalInflows =
PrivateCapitalInflows − ∆Target2Balance + EU/IMF net inflows −
∆ForeignReserves.
Thus, given an erosion of private capital inflows, the change in Target2
liabilities has to make up for repatriated funds from abroad as well as capital
outflows by residents for total capital inflows to stay constant (see, e.g.,
Cour-Thimann, 2013).
Increase in Target2 liabilities is thus a measure of when and to which extent
banks have substituted dried up private capital inflows with liquidity provided
by the central bank.

Claudia M. Buch, Manuel Buchholz, Alexander Lipponer, Esteban Prieto. Unit labor cost adjustments since the crisis in GIIPS vs. BELL countries: The role of central bank liquidity and rescue packages

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Claudia M. Buch, Manuel Buchholz, Alexander Lipponer, Esteban Prieto. Unit labor cost adjustments since the crisis in GIIPS vs. BELL countries: The role of central bank liquidity and rescue packages