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The real effects of financial stress in the Eurozone

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  • Mallick, Sushanta K.
  • Sousa, Ricardo M.

Abstract

This paper examines the real effects of financial stress in the Euro-zone, using two identification strategies based on a Bayesian Structural VAR and a Sign-Restriction VAR. As expansionary monetary policy has been blamed to have fuelled asset price bubble, it is important to assess the macroeconomic impact of both a financial stress shock and a monetary policy shock. We find that unexpected variation in financial stress conditions plays an important role in explaining output fluctuations and, therefore, demands an aggressive response by the monetary authority to stabilize output. This, in turn, indicates a preference shift from inflation targeting. We also show that a monetary policy contraction strongly deteriorates financial stress conditions. As a result, rapid credit growth due to a long period of low interest rates possibly contributed to an increase in asset prices and encouraged unsustainable demand growth as observed in the recent financial crisis.

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Bibliographic Info

Article provided by Elsevier in its journal International Review of Financial Analysis.

Volume (Year): 30 (2013)
Issue (Month): C ()
Pages: 1-17

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Handle: RePEc:eee:finana:v:30:y:2013:i:c:p:1-17

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Web page: http://www.elsevier.com/locate/inca/620166

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Keywords: Monetary policy; Financial stress; Bayesian Structural VAR; Sign-Restrictions; Eurozone;

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References

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  1. Aksoy, Yunus & León-Ledesma, Miguel A., 2005. "Interest rates and output in the long-run," Working Paper Series 0434, European Central Bank.
  2. Marco A. Espinosa-Vega, 1998. "How powerful is monetary policy in the long run?," Economic Review, Federal Reserve Bank of Atlanta, issue Q 3, pages 12-31.
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  5. Uhlig, Harald, 1999. "What are the Effects of Monetary Policy on Output? Results from an Agnostic Identification Procedure," CEPR Discussion Papers 2137, C.E.P.R. Discussion Papers.
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  17. repec:fip:fedreq:y:2011:i:3q:p:209-254:n:vol.97no.3 is not listed on IDEAS
  18. Vincenzo Quadrini, 2011. "Financial frictions in macroeconomic fluctations," Economic Quarterly, Federal Reserve Bank of Richmond, issue 3Q, pages 209-254.
  19. Philip Cagan, 1972. "Introduction to "The Channels of Monetary Effects on Interest Rates"," NBER Chapters, in: The Channels of Monetary Effects on Interest Rates, pages 1-8 National Bureau of Economic Research, Inc.
  20. Urban Jermann & Vincenzo Quadrini, 2012. "Erratum: Macroeconomic Effects of Financial Shocks," American Economic Review, American Economic Association, vol. 102(2), pages 1186-1186, April.
  21. Nicholas Bloom, 2007. "The Impact of Uncertainty Shocks," NBER Working Papers 13385, National Bureau of Economic Research, Inc.
  22. Granville, Brigitte & Mallick, Sushanta, 2009. "Monetary and financial stability in the euro area: Pro-cyclicality versus trade-off," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 19(4), pages 662-674, October.
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Cited by:
  1. Mittnik, Stefan & Semmler, Willi, 2013. "The real consequences of financial stress," Journal of Economic Dynamics and Control, Elsevier, vol. 37(8), pages 1479-1499.

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