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Financial Sector and Output Dynamics in the Euro Area: Non-linearities Reconsidered

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  • Schleer, Frauke
  • Semmler, Willi

Abstract

We analyze the feedback mechanisms between economic downturns and financial stress for several euro area countries. Our study employs newly constructed financial condition indices that incorporate banking variables extensively. We apply a non-linear Vector Smooth Transition Autoregressive (VSTAR) model for investigating instabilities in the link between the financial sector and economic activity. The VSTAR model allows for non-linear dynamics and regime changes between low and high stress regimes. It can also replicate the regime-specific amplification effects shown by our theoretical model. The amplification effects, however, change over time. Specifically after the Lehman collapse, we observe the presence of strong non-linearities and amplification mechanisms for some euro area countries. Thus, these strong amplification effects appear to be related to rare but large events, and to a low-frequency financial cycle. Prior to the financial crisis outbreak we find corridor stability even if the financial sector shock takes place in a high stress regime. More important seems to be the shock propagation over time in the economy. Only with the occurrence of the rare but large events we find strong endogenous feedback loops and a loss of stability as described by the high stress regime of our theoretical model. The economy leaves the corridor of stability and is prone to adverse feedback loops.

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  • Schleer, Frauke & Semmler, Willi, 2014. "Financial Sector and Output Dynamics in the Euro Area: Non-linearities Reconsidered," Annual Conference 2014 (Hamburg): Evidence-based Economic Policy 100578, Verein für Socialpolitik / German Economic Association.
  • Handle: RePEc:zbw:vfsc14:100578
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    Cited by:

    1. Mittnik, Stefan & Semmler, Willi, 2018. "Overleveraging, Financial Fragility, And The Banking–Macro Link: Theory And Empirical Evidence," Macroeconomic Dynamics, Cambridge University Press, vol. 22(01), pages 4-32, January.
    2. Kappler, Marcus & Schleer, Frauke, 2017. "A financially stressed euro area," Economics - The Open-Access, Open-Assessment E-Journal, Kiel Institute for the World Economy (IfW), vol. 11, pages 1-37.
    3. repec:eee:dyncon:v:91:y:2018:i:c:p:190-205 is not listed on IDEAS
    4. Tomas Konecny & Oxana Babecka-Kucharcukova, 2016. "Credit Spreads and the Links between the Financial and Real Sectors in a Small Open Economy: The Case of the Czech Republic," Czech Journal of Economics and Finance (Finance a uver), Charles University Prague, Faculty of Social Sciences, vol. 66(4), pages 302-321, August.
    5. repec:eee:dyncon:v:81:y:2017:i:c:p:115-139 is not listed on IDEAS
    6. Mauro Napoletano & Andrea Roventini & Jean-Luc Gaffard, 2015. "Time-Varying Fiscal Multipliers in an Agent-Based Model with Credit Rationing," LEM Papers Series 2015/19, Laboratory of Economics and Management (LEM), Sant'Anna School of Advanced Studies, Pisa, Italy.
    7. Willi Semmler & Alexander Haider, 2016. "The perils of debt deflation in the Euro area: a multi regime model," Empirica, Springer;Austrian Institute for Economic Research;Austrian Economic Association, vol. 43(2), pages 257-278, May.
    8. Ernst, Ekkehard & Semmler, Willi & Haider, Alexander, 2017. "Debt-deflation, financial market stress and regime change – Evidence from Europe using MRVAR," Journal of Economic Dynamics and Control, Elsevier, vol. 81(C), pages 115-139.
    9. Timo Teräsvirta, 2909. "Nonlinear models in macroeconometrics," CREATES Research Papers 2017-32, Department of Economics and Business Economics, Aarhus University.
    10. Claire-Océane Chevallier, 2017. "Empirical Investigation of the Effect of Bank Long Term Debt on Loans and Output in the Euro-zone," CREA Discussion Paper Series 17-04, Center for Research in Economic Analysis, University of Luxembourg.
    11. Demetrescu, Matei & Leppin, Julian Sebastian & Reitz, Stefan, 2017. "Homogenous vs. heterogenous transition functions in smooth transition regressions: A LM-type test," Kiel Working Papers 2094, Kiel Institute for the World Economy (IfW).
    12. repec:kap:annfin:v:14:y:2018:i:1:d:10.1007_s10436-017-0310-3 is not listed on IDEAS
    13. repec:eee:ecofin:v:43:y:2018:i:c:p:141-157 is not listed on IDEAS
    14. Mauro Napoletano & Andrea Roventini & Jean Luc Gaffard, 2015. "Toward a low carbon growth in Mexico : is a double dividend possible ? A dynamic general equilibrium assessment," Documents de Travail de l'OFCE 2015-25, Observatoire Francais des Conjonctures Economiques (OFCE).
    15. repec:eee:dyncon:v:91:y:2018:i:c:p:469-484 is not listed on IDEAS
    16. Willi Semmler & Brigitte Young, 2017. "Re-Booting Europe: What kind of Fiscal Union - What kind of Social Union?," Working Papers 1713, New School for Social Research, Department of Economics.

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    JEL classification:

    • E20 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - General (includes Measurement and Data)
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G01 - Financial Economics - - General - - - Financial Crises

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