Macro-financial Linkages Research Articles

Macrofinancial linkages and income distribution in the South African economy

ABSTRACT This study examines the impact of financial factors and income distribution on aggregate demand and growth in South Africa, using data spanning 1980–2019. We applied the autoregressive-distributed-lag bounds-testing procedure to uncover the effects over the short-and-long-run horizons. Additionally, we estimated impulse response functions to reveal further dynamic interactions. Our findings indicate that the key financial factors affecting the South African real economy are credit growth, interest rates, house prices and exchange rates. House prices play an important role, via the collateral channel, in driving consumption demand. Meanwhile, credit growth stifles investment demand in the long run. Interest rates constrain demand and growth, while the strengthening of exchange rates improves investment for firms. However, exchange rates impact negatively on GDP, presumably, through the trade-channel. We also found that income inequality suppresses consumption and investment demand, as well as GDP. This suppression appeared to be relatively pronounced in the short run for investment and growth, while for consumption, the suppressive impact was persistent. Therefore, we recommend that any policy framework aiming to galvanise growth should not overlook the problem of inequality. Otherwise, any headway made on growth will be back-pedalled by the demand-reducing impact of high-income inequality.

Inspecting cross-border macro-financial mechanisms

We model structural time-varying macro-financial linkages between the U.S. and euro area using a large dataset for each region. We extract both real and financial cycles and identify shocks, using a factor model with drifting parameters. To interpret the mechanisms that drive the empirical results, we contextualize our estimates using a two-country financial accelerator model. Our evidence speaks clearly of an asymmetric cross-border transmission between U.S. and euro area, especially in the financial domain. This is confirmed by our theoretical complement, which shows a strong transmission of U.S. TFP shocks. Moreover, the U.S. is a more leveraged economy, which accentuates the financial accelerator effect.

The term effect of financial cycle variables on GDP growth

We study how current financial cycle variables (house prices, credit-to-GDP, and share prices) influence the entire distribution of future GDP growth. Changes in financial cycle variables affect borrowers’ and lenders’ balance sheets, resulting in the lower quantile of GDP growth to be more sensitive to the financial accelerator, while the upper quantiles are relatively stable over horizons. We also find the combination of the rapid growth in asset prices and higher leverage amplifies the effect of asset prices on the downside of GDP growth. Moreover, we rely upon financial cycles constructed using two popular methods to investigate the impact on the distribution of GDP growth. The findings are consistent with the impact of financial cycle variables. In addition, we execute a series of robustness tests and find that the results survive. Our results suggest that policymakers should consider the risk-return tradeoff between economic growth and financial stability in the term structure emanating from macro-financial linkages. Specifically, policies regarding credit expansion and contraction combined with the regulation of house and equity prices should be calibrated to the state of GDP growth.

Volatility spillovers between oil and financial markets during economic and financial crises: A dynamic approach

Volatility in international oil markets is a recurrent phenomenon which causes spillovers on financial markets. However, a bidirectional comparison between the dynamic behavior of economic and financial crises has not been documented yet. This paper addresses this research question by employing a combined GARCH-VAR-Spillover Index methodology to measure the volatility of the WTI and the Brent in order to analyze its relationship with the SP500, NASDAQ, DAX and the IBEX for a sample corresponding to the period [2000:01, 2021:04]. Specifically, this paper compares the dynamic behavior of spillovers during the 2007-2009 financial crisis (taken as the financial crisis) and the COVID-19 pandemic (taken as the economic crisis). It has been found that there exists statistically significant net volatility shocks and spillovers from oil to stocks markets in the majority of cases and periods. These spillovers are bidirectional, and the net relationship is reversed depending on the market and the time period. The dynamic behavior of such spillovers depends on the region, being the USA more reactive to the source of the crisis than Europe. In particular, in the USA when the crisis is originated by financial shocks, financial markets are net transmitters of volatility to oil markets. When the source of the shock is economic, oil markets are net transmitters of volatility to stocks markets. This is not the case for Europe, where financial markets seem to be either transmitters or receivers of volatility no matter the source of the shock. In general, our study offers new evidence to understand macro-financial linkages.

Examining financial and business cycle interaction using cross recurrence plot analysis

It is of crucial importance that policymakers understand the level of convergence and synchronicity between the real and financial economy given the financial nature of the 2008 crisis. This paper aims to further such an understanding using recurrence analysis, which is a non-parametric technique frequently used in the sciences. The results suggest that evidence of convergence and syntonisation between the business and financial cycle in the US is visible. The technique presented in this paper has the potential to contribute to policy debates regarding early warning systems (EWS) and macro-financial linkages.

The Term Structure of Growth-at-Risk

We show that the conditional distribution of forecasted GDP growth depends on financial conditions in a panel of 11 advanced economies. Financial conditions have a larger effect on the lower fifth percentile of conditional growth—which we call growth-at-risk (GaR)—than the median. In addition, the term structure of GaR reflects that when initial financial conditions are loose, downside risks are lower in the near term but increase in later quarters. This intertemporal tradeoff for loose financial conditions is amplified when credit-to-GDP growth is rapid. Using granular instrumental variables, we also provide evidence that the relationship from loose financial conditions to future downside risks is causal. Our results suggest that models of macrofinancial linkages should incorporate the endogeneity of higher-order moments to systematically account for downside risks to growth in the medium run. (JEL E23, E27, E32, E44)

Philippines: Financial Sector Assessment Program-Technical Note on Risk Assessment of Banks, Non-Financial Corporates, and Macro-Financial Linkages

"Volume 2022 (2022): Issue 155 (Jun 2022): Philippines: Financial Sector Assessment Program-Technical Note on Risk Assessment of Banks, Non-Financial Corporates, and Macro-Financial Linkages" published on 07 Jun 2022 by International Monetary Fund.

Characterizing India’s Financial Cycle

The severity of the effects of global financial crisis resuscitates the need for assessing the macro-financial linkages and measuring financial cycle to prevent the economy from major financial shocks. Our article measures financial cycle by using turning point analysis, spectral analysis and band-pass filter and provides the evidence on the existence of financial cycle in India. We find the length and duration of cycles in financial variables are much greater as compared to the business cycle. While both credit and equity prices drive financial cycles over time, the contribution of house prices has increased since mid-2000s. We find that the expansionary phase of the financial cycle provides an early warning signal about stress build-up in the banking sector and impending depress in the economy. JEL Codes: C22, E30, E44, E58, G18

IDENTIFYING FINANCIAL CONDITION INDEXES FOR VIETNAM

This research constructs a financial condition index (FCI) for Vietnam to explore the macro-financial linkages in the country. This index is constructed by applying the principal components analysis (PCA) method. The FCI is constructed using monthly data from 2000 to 2020 and is based on a set of financial variables, including variables that define the state of international financial markets, asset prices, interest rate spreads, stock market, bond market, and monetary aggregates. We found that FCI could predict the fluctuations of the industrial index and inflation rate from 1 to 3 months in Vietnam. This result plays an important role in helping policymakers and investors in the market to make relevant decisions in the management and investment in the financial market.

An Extended Quarterly Projection Model: Credit Cycle, Macrofinancial Linkages and Macroprudential Measures: The Case of the Philippines

"Volume 2021 (2021): Issue 256 (Oct 2021): An Extended Quarterly Projection Model: Credit Cycle, Macrofinancial Linkages and Macroprudential Measures: The Case of the Philippines" published on 22 Oct 2021 by International Monetary Fund.

Collateral Constraints, Wage Rigidity, and Jobless Recoveries

Abstract The Great Recession has drawn attention to the importance of macro-financial linkages. In this paper I explore the joint role of imperfections in labor and financial markets for the cyclical adjustment of the labor market. I show that jobless recoveries emerge when, upon exiting a recession, firms are faced with deteriorating credit conditions. On the financial side, collateral requirements affect the cost of borrowing for firms. On the employment side, hiring frictions and wage rigidity increase the need for credit, making the binding collateral constraint more relevant. In a general equilibrium business cycle model with search and matching frictions, I illustrate that tightening credit conditions calibrated from data negatively affect employment adjustments during recovery periods. Wage rigidity substantially amplifies this mechanism, generating empirically plausible fluctuations in employment and output.

Financial volatility modeling with option-implied information and important macro-factors

The research debate on the informational content embedded in option prices mostly approves the incremental predictive power of implied volatility estimates for financial volatility forecasting beyond that contained in GARCH and realized variance models. Contributing to this ongoing debate, we introduce the novel AIM-HEAVY model, a tetravariate system with asymmetries, option-implied volatility, and economic uncertainty variables beyond daily and intra-daily dispersion measures included in the benchmark HEAVY specification. We associate financial with macroeconomic uncertainties to explore the macro-financial linkages in the high-frequency domain. In this vein, we further focus on economic factors that exacerbate stock market volatility and represent major threats to financial stability. Hence, our findings are directly connected to the current world-wide Coronavirus outbreak. Financial volatilities are already close to their crisis-peaks amid the generalized fear about controversial economic policies to support societies and the financial system, especially in the case of the heavily criticized UK authorities’ delayed and limited response.

An Extended Quarterly Projection Model: Credit Cycle, Macrofinancial Linkages and Macroprudential Measures: The Case of the Philippines

An Extended Quarterly Projection Model: Credit Cycle, Macrofinancial Linkages and Macroprudential Measures: The Case of the Philippines

МІЖНАРОДНИЙ ВАЛЮТНИЙ ФОНД НА СУЧАСНОМУ ЕТАПІ

The article examines the evolution of the reform of the International Monetary Fund. It is noted that there are two large groups in the issue of reforming the International Monetary Fund. Proponents of the first group believe that the IMF as an intergovernmental organization is outdated and ineffective. Scholars of the second group emphasize the need for the existence of the Fund and emphasize its reform. The impact of the 2008 global crisis on IMF reform has been analyzed in detail. In September 2008, the global crisis entered a new phase, characterized by a rapid and significant exacerbation. With this in mind, the IMF has identified policy objectives, including the need to pay more attention to macro financial linkages, reform its lending instruments, analyze the Fund’s role in financing member states and its resources, and provide emergency financing to countries affected by the crisis. The global crisis of 2007–2009 led to the need to develop a new concept of development and operation of the Fund, to reconsider the principles of its operation. The essence of the IMF reform, which was launched in 2008 and continues to this day, was a revision of the Fund’s quota allocation mechanism and credit policy to better provide its members with credit in the face of budget deficits. The Fund’s management has concluded that the income model that the IMF has followed since its inception does not provide sustainable funding for the Fund. According to this conclusion, the Executive Board agreed on the following measures: to propose an amendment to the Articles of the Agreement on the expansion of the Fund’s investment powers, which would allow the Fund to pursue an expanded investment policy and adjust its investment strategy with best practices. It is noted that the IMF usually puts forward approximately the same package of requirements, which includes: privatization of large enterprises, liberalization of prices and foreign trade, tight monetary policy to stabilize the currency, stop subsidizing unprofitable enterprises, and minimize budget deficits by reducing social programs and tax increases, currency devaluation.

Credit Allocation and Macroeconomic Fluctuations

We study the relationship between credit expansions, macroeconomic fluctuations, and financial crises using a novel database on the sectoral distribution of private credit for 117 countries starting in 1940. Theory predicts that the sectoral allocation of credit matters for distinguishing between “good” and “bad” credit booms. We test the prediction that lending to households and the non-tradable sector, relative to the tradable sector, contributes to macroeconomic boom-bust cycles by (i) fueling unsustainable demand booms, (ii) increasing financial fragility, and (iii) misallocating resources across sectors. We show that credit to non-tradable sectors, including construction and real estate, is associated with a boom-bust pattern in output, similar to household credit booms. Such lending booms also predict elevated financial crisis risk and productivity slowdowns. In contrast, tradable-sector credit expansions are followed by stable output and productivity growth without a higher risk of a financial crisis. Our findings highlight that what credit is used for is important for understanding macro-financial linkages.

Implications of household-level evidence for policy models: the case of macro-financial linkages

AbstractMacroeconomic policy models should track the different channels of monetary transmission, providing a framework for Monetary Policy Committees. They should also be useful for assessing risks to financial stability, including for designing macroprudential stress tests and instrument settings in the new macroprudential toolkits. Current policy models, including the ‘semi-structural’ non-DSGE econometric models such as FRB-US, are seriously deficient in these respects, failing to capture the credit channel and the role of real estate in the financial accelerator that operated in the global financial crisis, and in key transmission channels in the recovery. Furthermore, developments in economic theory, greatly encouraged by new evidence, have rendered redundant the previously accepted micro-foundations for household behaviour in these policy models.A multi-purpose policy model needs to include a household-housing sub-system. This should contain a consumption function broadly consistent with the micro-evidence with equations for permanent income, for the balance sheet drivers, and for residential investment. To capture the credit channel, this block of the model needs to embed common credit conditions in the equations. Sub-system estimation is required to impose the cross-equation restrictions implied by these common factors.

COVID-19 Outbreak and CO2 Emissions: Macro-Financial Linkages

In the Dynamic Conditional Correlation with Mixed Data Sampling (DCC-MIDAS) framework, we scrutinize the correlations between the macro-financial environment and CO2 emissions in the aftermath of the COVID-19 diffusion. The main original idea is that the economy’s lock-down will alleviate part of the greenhouse gases’ burden that human activity induces on the environment. We capture the time-varying correlations between U.S. COVID-19 confirmed cases, deaths, and recovered cases that were recorded by the Johns Hopkins Coronavirus Center, on the one hand; U.S. Total Industrial Production Index and Total Fossil Fuels CO2 emissions from the U.S. Energy Information Administration on the other hand. High-frequency data for U.S. stock markets are included with five-minute realized volatility from the Oxford-Man Institute of Quantitative Finance. The DCC-MIDAS approach indicates that COVID-19 confirmed cases and deaths negatively influence the macro-financial variables and CO2 emissions. We quantify the time-varying correlations of CO2 emissions with either COVID-19 confirmed cases or COVID-19 deaths to sharply decrease by −15% to −30%. The main takeaway is that we track correlations and reveal a recessionary outlook against the background of the pandemic.

Estimation of Macro-financial Linkages for the Indian Economy

The widespread impacts of global financial crisis (2008-09) reinstate the need for better assessment of the macro-financial linkages for forecasting and policy evaluation. Our paper contributes to the relevant literature with evidence from the Indian financial sector. Following Castelnuovo (2013), a New Keynesian model with macro-financial linkages is estimated by the Bayesian technique for the sample period 2004: Q3 to 2019: Q1. We find that, in an Emerging Market Economy like India, business cycle leads financial cycle through the channel of expectations. Further, our results show that the linkages are heterogeneous in size depending on the financial market segment and market-specific shocks. JEL Codes: C11, E44, G10

Macrofinancial linkages in Europe: Evidence from quantile local projections

AbstractThe paper investigates macrofinancial linkages in the sample of 16 European economies over January 1997–December 2019 from a new twofold perspective. First, we put a particular emphasis on the role of news‐based sentiment measures in these relationships, that is, economic policy uncertainty and global geopolitical risk. Second, we pursue a hybrid econometric approach to capture a presumably nonlinear nature of these linkages by building on different quantiles of the data series and estimating impulse responses from smooth local projections (Barnichon and Brownlees, Review of Economics and Statistics, 101(3), 522–530, 2019). Our results legitimize such approach as the number of statistically significant impulse responses based on this approach is skewed towards upper (75th and 90th) quantiles. We find that global economic policy uncertainty index dampens the growth rates of industrial production in Austria, France, Italy, Luxembourg and Slovakia, which calls for specific measures to mitigate this adverse effect at the national level, for example, by curtailing yellow journalism, populist ideas and disbeliefs. However, there is only minor evidence for the relationship running between economic policy uncertainty and financial stress. Global geopolitical risk appears irrelevant in the country‐ and panel‐level analyses. Meanwhile, the VIX index performs a pervasive role in undermining industrial production and increasing economic policy uncertainty in Europe.

Stress Testing in Sub-Saharan Africa

The paper finds that supervisory stress tests are conducted in more than half of sub-Saharan African countries, particularly in western and southern Africa, and that the number of individual stress tests has grown exponentially since the early 2010s. By contrast, few central banks publish assessments of macro-financial linkages; the focus leans more toward discussing trends and weaknesses within the financial sector than on outside risks that may negatively affect its performance.