Overleveraging, Financial Fragility and the Banking-Macro Link: Theory and Empirical Evidence

41 Pages Posted: 27 Jan 2015

See all articles by Stefan Mittnik

Stefan Mittnik

Ludwig Maximilian University of Munich (LMU)

Willi Semmler

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

Date Written: November 20, 2014

Abstract

We investigate consequences of overleveraging and financial sector stress on real economic activities. When banks become vulnerable, due to high leveraging, and there is a strong feedback between the real and the financial sector, a regime of high financial stress may arise. The vulnerability of the banking system in a high leverage and a high-stress regime can, through macro feedback effects, result in unstable dynamics. To assess this question empirically, we employ a nonlinear, multi regime vector autoregression approach (MRVAR), to explore the consequences of instabilities arising from regime dependent shocks. We analyze data on industrial production and the IMF Financial Stress Index. In order to assess how output is affected by the individual risk drivers making up the IMF index, we study eight economies, the U.S., Canada, Japan and the UK, and for the four largest euro zone economies, namely, Germany, France, Italy, and Spain, using Granger-causality and nonlinear impulse response analysis. Our results strongly suggest that financial sector stress, exerts a strong, nonlinear influence on economic activity, but that individual risk drivers affect economic activity rather differently across stress regimes and across countries.

JEL Classification: E2, E6, C13

Suggested Citation

Mittnik, Stefan and Semmler, Willi, Overleveraging, Financial Fragility and the Banking-Macro Link: Theory and Empirical Evidence (November 20, 2014). ZEW - Centre for European Economic Research Discussion Paper No. 14-110. Available at SSRN: https://ssrn.com/abstract=2555466 or http://dx.doi.org/10.2139/ssrn.2555466

Stefan Mittnik

Ludwig Maximilian University of Munich (LMU) ( email )

Geschwister-Scholl-Platz 1
Munich, DE Bavaria 80539
Germany

Willi Semmler (Contact Author)

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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