F36 Financial Aspects of Economic Integration

December 5, 2011

We study how credit supply shocks in the US, the euro area and Japan are transmitted to other economies. We use the recently-developed GVAR approach to model financial variables jointly with macroeconomic variables in 33 countries for the period 1983-2009. We experiment with inter-country links that distinguish bilateral trade, portfolio investment, foreign direct investment and banking exposures, as well as asset-side vs. liability-side financial channels. Capturing both bilateral trade and inward foreign direct investment or outward banking claim exposures in a GVAR fits the data better than using trade weights only. We use sign restrictions on the short-run impulse responses to financial shocks that have the effect of reducing credit supply to the private sector. We find that negative US credit supply shocks have stronger negative effects on domestic and foreign GDP, compared to credit supply shocks from the euro area and Japan. Domestic and foreign credit and equity markets respond clearly to the credit supply shocks. Exchange rate responses are consistent with a "flight to quality" to the US dollar. The UK, another international financial centre, is also responsive to the shocks. These results are robust to the exclusion of the 2007-09 crisis episode from the sample.

Download the paper [448.82 KB]

June 10, 2011

This paper provides an empirical investigation of both the within-US and international channels of transmission of macroeconomic and financial shocks by means of a 50-country macroeconometric model (estimated over the 1980-2009 period), including measures of excess liquidity and financial fragility, specifically designed in order to evaluate the relevance of the boom-bust credit cycle view put forward as an interpretation of the recent "Great Recession" episode. We find that such a view is consistent with the empirical evidence. Moreover, concerning the real effects of financial shocks within the US, we detect stronger evidence of an asset prices channel, rather than a liquidity channel. Concerning the spillovers to the world economy, we find that while financial disturbances are transmitted to foreign countries through US house and stock price dynamics, as well as excess liquidity creation, the trade channel is the key trasmission mechanism of real shocks.

Download the paper [423.57 KB]

March 1, 2009

We study the cross-section correlations of net, total, and disaggregated capital flows for the major source and recipient European Union countries. We seek evidence of changes in these correlations since the introduction of the euro to understand whether the European Union can be considered a unique entity with regard to its international capital flows. We make use of Ng’s (2006) “uniform spacing” methodology to rank cross-section correlations and shed light on potential common factors driving international capital flows. We find that a common factor structure is suitable for equity flows disaggregated by sign but not for net and total flows. We only find mixed evidence that correlations between types of flows have changed since the introduction of the euro.

Download the paper [301.89 KB]

December 1, 2004

According to the traditional 'optimum currency area' approach, the case for adopting a common currency is stronger if the countries are subject to relatively similar output shocks. This Paper takes a different approach and highlights the fact that high exchange rate volatility may as well signal high costs for labour markets. The impact of exchange rate volatility on labour markets in the CEECs is analysed, finding that volatility vis-à-vis the euro significantly lowers employment growth and raises the unemployment rate. Hence, the elimination of exchange rate volatility can be considered equally important for labour markets as a removal of employment protection legislation.

Download the paper [332.34 KB]