Financial Integration in Europe Through the Lens of Composite Indicators

Abstract

This paper develops composite indicators of financial integration within the euro area for both price-based and quantity-based indicators covering money, bond, equity and banking markets. Prior to aggregation, individual integration indicators are harmonised by applying the probability integral transform. We find that financial integration in Europe increased steadily between 1995 and 2007. The subprime mortgage crisis marked a turning point, bringing about a marked drop in both composite indicators. This fragmentation trend reversed when the European banking union and the ECB's Outright Monetary Transactions Programme were announced in 2012, with financial integration recovering more strongly when measured by price-based indicators. In a growth regression framework, we find that higher financial integration can be associated with an increase in per capita real GDP growth in euro area countries. In times of high financial stress, however, such a positive correlation between financial integration and growth seems to break down.

Keywords: composite indicator, economic growth, European Monetary Union, financial integration, financial stress

JEL Classification: F36, F43, F45, G01, G15