Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/82626 
Year of Publication: 
2013
Series/Report no.: 
ZEW Discussion Papers No. 13-068
Publisher: 
Zentrum für Europäische Wirtschaftsforschung (ZEW), Mannheim
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 financial 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 effect of financial stress on output typically observed is not always present. This holds specifically for the time before the Lehman collapse, even if this is a model-defined high stress regime. After the collapse, we observe strong amplification 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.
Subjects: 
Vector STAR
financial stress
financial cycle
real economy
regime-switching
euro area
JEL: 
E2
E44
G01
Persistent Identifier of the first edition: 
Document Type: 
Working Paper

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