The international impact of a fragile EMU

Abstract

This paper aims at quantifying the international impact of euro area stress shocks, which arise also from the incomplete nature of the European Economic and Monetary Union (EMU). We first disentangle such shocks from more general global risk aversion shocks by using sign, magnitude and narrative restrictions in a daily Structural Vector Autoregression (SVAR) model with financial variables. We then assess the impact of euro area stress shocks on macroeconomic variables in the euro area and the rest of the world via panel local projections. We find that these shocks have similar effects to supply-side shocks for other advanced economies, and demand-side shocks for emerging economies. They also result in trade diversion across advanced and emerging economies and they are found to be noticeably more heteroscedastic than global shocks. As in previous literature, global risk shocks have an impact that can be interpreted as a demand-side shock, with a significant fall in economic activity and trade after risk-increasing shocks.