Coherence and Entropy of Credit Cycles across the Euro Area Candidate Countries.

Adina Criste,Radu Lupu,Iulia Lupu

doi:10.3390/e23091213

Adina Criste, Radu Lupu + Show 1 more

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https://doi.org/10.3390/e23091213

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Abstract

The pattern of financial cycles in the European Union has direct impacts on financial stability and economic sustainability in view of adoption of the euro. The purpose of the article is to identify the degree of coherence of credit cycles in the countries potentially seeking to adopt the euro with the credit cycle inside the Eurozone. We first estimate the credit cycles in the selected countries and in the euro area (at the aggregate level) and filter the series with the Hodrick–Prescott filter for the period 1999Q1–2020Q4. Based on these values, we compute the indicators that define the credit cycle similarity and synchronicity in the selected countries and a set of entropy measures (block entropy, entropy rate, Bayesian entropy) to show the high degree of heterogeneity, noting that the manifestation of the global financial crisis has changed the credit cycle patterns in some countries. Our novel approach provides analytical tools to cope with euro adoption decisions, showing how the coherence of credit cycles can be increased among European countries and how the national macroprudential policies can be better coordinated, especially in light of changes caused by the pandemic crisis.

Highlights

Lending activity, which is subject to medium-term fluctuations, is one of the determining factors influencing financial stability, with excessive growth in lending activity over a period being an important signal of risk accumulation
Based on the above observations and the importance of the coherence of financial cycles within a monetary area, this article aims to determine the degree of coherence of credit cycles in euro area candidate countries with the euro area credit cycle, which is taken as a reference
As a general conclusion that emerges from this study, the heterogeneous character of lending activity across the euro area candidate countries is highlighted, both in terms of the entropy of credit cycles and their coherence in relation to the euro area reference

Summary

Introduction

Lending activity, which is subject to medium-term fluctuations, is one of the determining factors influencing financial stability, with excessive growth in lending activity over a period being an important signal of risk accumulation. Under the European economic integration process, financial stability and the dynamics of financial activity have increased importance. The global financial crisis has been a key factor in the increasing interest in the dynamics of lending and the financial cycle, including in European countries. The credit cycle, which is a common way to empirically measure the financial cycle [1], is an important element that can explain the differences between countries both in terms of economic growth and stability, as well as the effects of political decisions. The financial cycle was closely linked to increases in financing and intermediation in the advanced economies in the 1970s, which caused severe recessions, boom and bust cycles, and financial instability, and to an exponential increase in cross-border lending [2]

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