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Euro area financial shocks and economic activity in The Netherlands

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Abstract

We analyze the effects of shocks on financial markets on economic development in the Euro area and the Netherlands in particular. We develop a VAR model that takes account of feedback loops between financial market conditions and the real economy. These feedback loops operate via the aggregated Euro area level for the real economy as well as financial markets and affect the Dutch economy. Our empirical analysis considers industry data for the Euro area and the Dutch economy. Shocks on financial markets are measured as shocks to corporate bond spreads and implied volatility. For shock identification, we employ a recently proposed decomposition of the forecast error variance combined with an ordering perturbation in our VAR. Bond spread shocks are found to have severe consequences for real economic development independently whether they are accompanied by shocks to volatility. Shocks to volatility seem to imply only severe effects for parts of the real economy if they are accompanied by bond spread shocks.

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Notes

  1. By now there are several theoretical applications of this theory. Aghion et al. (2001, 2004a, b) and Schneider and Tornell (2004) relate the mechanism to currency crises. Cooley and Quadrini (2006), Matsuyama (2007) and Manova (2008) analyze the mechanism in models of heterogeneous firms and investment projects. Models that deal with contagion through financial accelerator mechanism can be found in Kyle and Xiong (2001), Paasche (2001), Boissay (2006) and Fostel and Geanakoplos (2008). Lorenzoni (2008) and Caballero and Krishnamurthy (2001, 2003) deal with the nature of capital market imperfections in this mechanism. Although these contributions are not directly linked to our empirical approach, they do highlight the importance of the mechanism.

  2. One might also consider the GVAR literature on geographic transmission of financial shocks as relevant. For contributions in this direction see e.g. Galesi and Sgherri (2009), Chen et al. (2010), Beaton and Desroches (2011), Xu (2010), Chudik and Fratzscher (2011), Bussiére et al. (2011) and Eickmeier and Ng (2011). This literature, however, does not model the possibility of a self enforcing dynamic evolvement of financial shocks as in the accelerator theory considered in the present contribution. This is because financial conditions are included as a global exogenous variable to a VAR.

  3. OECD.StatExtracts database http://stata.oecd.org.

  4. Interestingly, publication of these employment data has been recently stopped by all statistical bureaus with the ILO being the only exception. The data can be accessed via http://laborsta.ilo.org/.

  5. Eurostat database http://epp.eurostat.ec.europa.eu. Turn over series sts_ind_tovt, new order series sts_ind_nord, producer price indices sts_ind_pric.

  6. Given the values that are typically chosen in the literature [see e.g. Bańbura et al. (2010)] this seems to be an appropriate starting value.

  7. See Casella (2001) also on the detailed relation between including the hyperparameter selection in the Gibbs sampler and the marginal likelihood.

  8. Details on the VAR and prior specification can be found in the "Appendix" at the end of the paper.

  9. The non-uncertainty related financial and the non-financial related uncertainty shocks were identified by selecting the corresponding response functions which have an impact of <2 % and two basis points in absolute value.

  10. The Lehman shock is \(\frac{180}{25}\) times our 25 basis points shock which needs to be multiplied by the numbers given the text above.

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Acknowledgments

We would like to thank two anonymous referees, Gabriele Galati, members of the CPB, the Dutch Ministries of Economic Affairs, Finance and Social and Labor Affairs as well as the Nederlandsche Bank for very helpful comments. Especially, we would like to thank the Ministry of Economic Affairs for supporting this project. All remaining errors are our own.

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Authors and Affiliations

  1. CPB Netherlands Bureau for Economic Policy Analysis, P.O. Box 80510, 2508GM, The Hague, The Netherlands

    D. Peter Broer

  2. Pforzheim University, Tiefenbronner Str. 65, 75175, Pforzheim, Germany

    Jürgen Antony

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  1. Jürgen Antony
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  2. D. Peter Broer
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Correspondence to Jürgen Antony.

Appendix

Appendix

Specifications for the BVARs in Sect. 4. Ordering of variables is as given in Table 2. Table 3 gives the prios specifications.

Variable order for shock identification.

Table 2 Variable ordering
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Table 3 Prior specification
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Antony, J., Broer, D.P. Euro area financial shocks and economic activity in The Netherlands. Empirica 42, 571–595 (2015). https://doi.org/10.1007/s10663-014-9265-z

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