Financial channels and economic activity in the euro area: a large-scale Bayesian VAR approach

Abstract

This paper explores the nexus between financial and macroeconomic developments in the euro area. It draws on key lessons from the literature and provides stylised facts on the main transmission channels through which financial developments have affected real economic activity in the recent years. Specifically, a large-scale Bayesian VAR (Banbura et al. in Int J Forecast 31(3):739–756, 2015) is applied to set of macroeconomic and financial variables focusing at four key channels: (1) the interest rate channel; (2) the borrower balance sheet channel; (3) the bank balance sheet channel; and (4) the uncertainty channel. Overall, conditional forecasts from this model suggests that financial variables have significant impact on macroeconomic developments but also that the relative importance of individual channels varies across time. Notably, the interest rate channel (reflecting also the monetary policy stance) has helped the recovery in 2013/2014 by supporting both private and public consumption. The positive boost has been somewhat compensating the adverse effects of the borrower balance sheet channel. The bank balance sheet channel and the uncertainty channel play in turn a particularly important role in capturing the weakness in the rebound in investment.