Financial Sector and Output Dynamics in the Euro Area

March 4, 2014

This paper analyzes the feedback mechanisms between economic downturns and financial stress for several euro-area countries.

Using a newly constructed financial condition index with banking variables, the authors examine leadership changes in countries that have either high or low levels of financial stability and their ripple effects. Strong amplification effects appear to be related to rare, but large events such as the financial crisis, and to a low-frequency financial cycle. Prior to the financial crisis, economic shocks could be self-adjusting, even if the financial sector shock took place in a high-stress regime. Only with the occurrence of rare, but large events did they find a loss of stability.

Authors: Frauke Schleer and Willi Semmler
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