Macroeconomic imbalances and loan quality in panels of European countries

The paper investigates the relationship between loan quality and macroeconomic imbalance indicators. We use the local projection method to estimate the response of non-performing loans (NPL) to changes in the cyclical component of macroeconomic factors. The estimations are run for three country groups of Western European countries, Central and Eastern European countries, and Southern European countries. The results show that a rise in the output gap is followed by a rise in NPL in all country groups, while NPL responds to the unemployment rate in the Central and Eastern and Southern European countries. Inflation and real unit labour costs are positively related to NPL in all country groups, though they are estimated with large uncertainty in some country groups. The findings suggest that it is useful to monitor imbalances in the output gap, unemployment, inflation and labour costs together with credit indicators to assess the ensuing dynamics in NPL.