Tracking growth in the euro area subject to a dimensionality problem

Abstract

ABSTRACT Which variables have supported growth in the euro area over the last 30 years? Answering is challenging due to dimensionality problems caused by a large set of potential determinants, limited data availability, and the prospect of non-stationarity of some variables. We propose an atheoretical framework starting with a set of 35 real, financial, monetary, and institutional variables for nine of the initial euro area countries covering the period between 1990Q1 and 2019Q4. Using the Weighted-Average Least Squares method, we gather clues about which variables to select. We quantify the impact of various determinants of growth in the short and long runs. Our main findings are that institutional reforms, competitiveness, monetary policy and a decrease in systemic risk play a relevant role for long-run growth in the euro area. Surprisingly, the fiscal deficit is not an important factor, and neither is credit to households. Lower debt to GDP ratios are beneficial in the short run. Credit to firms has been an important factor for growth in core countries and an increase in global GDP spillovers positively to the euro area growth in a longer horizon.