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

59 Pages Posted: 30 Sep 2013

See all articles by Frauke Schleer

Frauke Schleer

ZEW – Leibniz Centre for European Economic Research

Willi Semmler

The New School - Department of Economics; Universitaet Bielefeld; IIASA

Date Written: September 10, 2013

Abstract

We 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 fi nancial 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 e ffect of financial stress on output typically observed is not always present. This holds specifi cally for the time before the Lehman collapse, even if this is a model-de fined high stress regime. After the collapse, we observe strong ampli fication 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.

Keywords: Vector STAR, financial stress, fi nancial cycle, real economy, regimeswitching, euro area

JEL Classification: E2, E44, G01

Suggested Citation

Schleer, Frauke and Semmler, Willi, Financial Sector-Output Dynamics in the Euro Area: Non-Linearities Reconsidered (September 10, 2013). ZEW - Centre for European Economic Research Discussion Paper No. 13-068. Available at SSRN: https://ssrn.com/abstract=2333592 or http://dx.doi.org/10.2139/ssrn.2333592

Frauke Schleer (Contact Author)

ZEW – Leibniz Centre for European Economic Research ( email )

P.O. Box 10 34 43
L 7,1
D-68034 Mannheim, 68034
Germany

Willi Semmler

The New School - Department of Economics ( email )

65 Fifth Avenue
New York, NY 10003
United States

HOME PAGE: http://www.newschool.edu/nssr/faculty/?id=4e54-6b79-4e41-3d3d

Universitaet Bielefeld ( email )

Universitätsstraße 25
Bielefeld, NRW
Germany

IIASA ( email )

Schlossplatz 1
Laxenburg/Austria, A-2361
Austria

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