Euro area financial shocks and economic activity in The Netherlands

We analyze the effects of shocks on financial markets on economic development in the Euro area and the Netherlands in particular. We develop a VAR model that takes account of feedback loops between financial market conditions and the real economy. These feedback loops operate via the aggregated Euro area level for the real economy as well as financial markets and affect the Dutch economy. Our empirical analysis considers industry data for the Euro area and the Dutch economy. Shocks on financial markets are measured as shocks to corporate bond spreads and implied volatility. For shock identification, we employ a recently proposed decomposition of the forecast error variance combined with an ordering perturbation in our VAR. Bond spread shocks are found to have severe consequences for real economic development independently whether they are accompanied by shocks to volatility. Shocks to volatility seem to imply only severe effects for parts of the real economy if they are accompanied by bond spread shocks. Copyright Springer Science+Business Media New York 2015