Capital Mobility as a Reason for Credit Booms in the Eurozone

Abstract

Purpose: The main goal of the paper is to establish the importance of capital mobility for the occurrence of the credit booms in some EMU countries, which contributed to the so-called Eurozone crisis in the previous decade. In particular, a causal relationship between foreign capital inflows and expansions of credit to the private sector in five advanced “periphery” Eurozone economies (Portugal, Italy, Ireland, Greece, and Spain) in 1996–2016 is examined. Design/Methodology/Approach: A threshold method for identifying credit booms, and the Granger causality test were applied to investigate the relationship between foreign capital inflows and expansion of credit to the private sector in the PIIGS countries. We used data of an annual frequency over the years 1996–2016 and discuss the effects of using different measures for both capital inflows and credit expansion. Findings: The results allowed the authors to identify and measure credit booms in the PIIGS countries from 2006 to 2011. It has been shown that one of the reasons for the over-indebtedness of households and companies in these countries was the inflow of cheap and easily accessible capital, especially in the form of portfolio investments. Practical Implications: The results of the research can be used to assess the importance of the free movement of capital for financial stability in Eurozone countries. Originality/Value: The study contributes to a better understanding of the functioning of the Economic and Monetary Union as regards the links between capital flows in the financial market and the emergence of credit booms.