Financial Stress and Economic Dynamics: Asymmetries Within and Across Euro Area Countries

Despite severe economic and political consequences of financial crises, the link between the financial sector and economic dynamics has not yet been sufficiently investigated. Recently, financial market frictions have been incorporated into theoretical models which serve to analyse the spillover mechanisms from the financial sector to the real economy. These models point to highly non-linear amplification effects which motivate our empirical analysis on the strength of instabilities and the corresponding dynamic mechanisms. To be specific, we aim at analysing the feedback mechanisms between economic downturns and financial stress and the role of the heterogeneity of the euro area countries, which have both not yet been adequately addressed in the literature. For this purpose, we will apply a non-linear Smooth Transition Vector Autoregressive model, an appropriate tool for investigating the aforementioned instabilities. Yet, substantial optimisation problems arise, which we address in our project and for which we offer a solution. The results will be data-based policy recommendations exhibiting a higher reliability than previous ones.

The project is in line with the core of the SEEK research programme. It will provide deeper insights into the consequences of an insufficiently integrated European economy, particularly on the role played by destabilising effects arising from the financial sector and its interdependent relation to economic activity. Thereby, it will contribute to a deeper understanding of policy rationales on both the national and supranational level in the euro area economies by means of a more reliable empirical model framework.

Duration: April 2012 - July 2013

Download ZEW policy brief - No. 9, December 2013

• Dr. Marcus Kappler, ZEW – Leibniz Centre for European Economic Research Mannheim, Research Group Growth and Business Cycles
• Frauke Schleer, ZEW – Leibniz Centre for European Economic Research Mannheim, Research Group Growth and Business Cycles
• Prof. Dr. Willi Semmler, New School University, Comparative Empirical Macroeconomics
• Prof. DPolSc. (Econometrics) Timo Teräsvirta, Aarhus University, Department of Economics and Business, Member of CREATES
• Prof. Dr. Peter Winker, Justus Liebig University Giessen, Head of Department of Statistics and Econometrics, and Research Associate at ZEW