Financial sector and output dynamics in the euro area: Non-linearities reconsidered

Abstract

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The perils of debt deflation in the Euro area: a multi regime model

“…In the normal regime, as depicted in figure 2, there is no financial market stress, and thus no credit spread. Next we want to allow for regime switching as it is demonstrated to be present in other empirical work and discussed in section 2 (see also Schleer and Semmler 2013). We study a model of regime switching in the IS curve where the actual credit cost, due to rising risk premia, is assumed to move up in a recessionary regime giving rise to financial stress and credit spreads.…”

“…The interest rate spread is calculated as the difference between longterm and short-term interest rate, where the long-term interest rate corresponds to Interest Rates, Government Securities, Government Bonds concept, while the short term interest rate is taken from Interest Rates, Treasury Bill Rate. Our fourth variable, the ZEW Financial Condition Indices (FCI), which acts as the endogenous threshold variable in our MRVAR model, is taken from Schleer and Semmler (2013). The index represents financial sector conditions and stress with a focus on the banking sector.…”

“…The index covers the banking sector, securities markets and foreign exchange markets. A more detailed description of the data can be found in Smith and Galesi (2014) and in Schleer and Semmler (2013).…”

“…Section 3.2 presents a theoretical model with financial market stress, while section 4 takes the banking sector stress variables -as part of the general stress index -into account, as we are estimating a multi-regime VAR with financial stress as the threshold variable. Our threshold variable is the ZEW Financial Condition Indices (FCI) and is taken from Schleer and Semmler (2013). 6 The remainder of the paper is organized as follows.…”

A financially stressed euro area

“…However, theories offer a much broader understanding of the sources and mechanisms that lead to the rise and propagation of shocks that manifest themselves in financial and economic data: Neoclassical channels of term structure and exchange rate shocks, amplification of macro shocks via financial accelerator mechanisms through endogenous developments in credit markets (Kiyotaki andMoore, 1997, Bernanke et al, 1999), credit supply cuts of banks due to balance sheet impairments caused by asset price shocks (Brunnermeier andSannikov, 2014, Mittnik and, shocks to uncertainty in "real option" models (e.g. Bloom, 2009), regime-specific "financial stress" shocks (Schleer and Semmler, 2013), risk shocks (Christiano et al, 2014), or housing price shocks (e.g. Iacoviello, 2005), to name a few.…”