Financial sector-output dynamics in the euro area: Non-linearities reconsidered
AbstractWe analyze the feedback mechanisms between economic downturns and financial stress for euro area countries. Our study employs newly constructed financial condition indices that incorporate extensively banking variables. We apply a nonlinear Vector Smooth Transition Autoregressive (VSTAR) model for investigating instabilities in the financial sector-output linkages. The VSTAR model appears appropriate since it allows for smooth regime changes and asymmetric dynamics. We find that regime-switching takes place rather smoothly which dampens the negative output response after a shock in the financial sector in the selected euro area countries. Moreover, linearity cannot be rejected for all countries over some extensive time period questioning non-linearities in the financial sector-output nexus as unambiguous feature. In particular, we show that the negative effect of financial stress on output typically observed is not always present. This holds specifically for the time before the Lehman collapse, even if this is a model-defined high stress regime. After the collapse, we observe strong amplification mechanisms. This suggests that events leading to a strong economic breakdown are rare but large events and related to financial cycles which exhibit low frequency. --
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Bibliographic InfoPaper provided by ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research in its series ZEW Discussion Papers with number 13-068.
Date of creation: 2013
Date of revision:
Vector STAR; financial stress; financial cycle; real economy; regime-switching; euro area;
Find related papers by JEL classification:
- E2 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment
- E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
- G01 - Financial Economics - - General - - - Financial Crises
This paper has been announced in the following NEP Reports:
- NEP-ALL-2013-10-11 (All new papers)
- NEP-BAN-2013-10-11 (Banking)
- NEP-EEC-2013-10-11 (European Economics)
- NEP-MAC-2013-10-11 (Macroeconomics)
- NEP-MON-2013-10-11 (Monetary Economics)
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