Macro-Financial Linkages: The Role of Liquidity Dependence

Abstract

We estimate a panel Bayesian vector autoregression model for a cross-section of seven advanced European economies and produce out-of-sample forecasts of GDP conditionally on observed developments of interest rates and credit. We show that, by using a smooth transition version of the model and allowing the parameters to vary across economies conditionally on their liquidity dependence (i.e. dependence on the availability of funding from external sources), it is possible to improve the accuracy of the forecasts. We conclude that the degree of liquidity dependence is likely to be among the important predictors of heterogeneity in macro-financial linkages across countries.

Keywords: liquidity dependence, macro-financial linkages, Smooth Transition Bayesian VAR

JEL Classification: G2, O16, C32