Institutions and macroeconomic performance: core versus periphery countries in the Eurozone

Abstract

We incorporate institutions into a neoclassical growth model so as to account for macroeconomic differences, as in the data, in 12 Eurozone countries. Modelling institutions in a generic way, we assume that weak institutions are reflected in ill-enforced property rights. When we calibrate and solve the model for each country separately, our results are: (i) including weak institutions helps the model vis-à-vis the data more in the periphery than in the core of the Eurozone; (ii) institutional failures, and their adverse effects on incentives, are worse in the periphery countries and this contributes in explaining lower long-term growth and higher output volatility in these countries; (iii) the same shock affects different countries differently depending on their institutional structure and the mix of fiscal policies; and (iv) counterfactual scenarios imply that periphery countries with weak institutions could gain a lot had their institutional quality been like that in the core.