Financial Conditions Index and Credit Supply Shocks for the Euro Area

Download or read book Financial Conditions Index and Credit Supply Shocks for the Euro Area written by and published by . This book was released on 2014 with total page 43 pages. Available in PDF, EPUB and Kindle. Book excerpt: We implement a two-step approach to construct a financing conditions index (FCI) for the euro area and its four larger member states (Germany, France, Italy and Spain). The method, which follows Hatzius et al. (2010), is based on factor analysis and enables to summarise information on financing conditions from a large set of financial indicators, controlling for the level of policy interest rates, changes in output and inflation. We find that the FCI tracks successfully both worldwide and euro area specific financial events. Moreover, while the national FCIs are constructed independently, they display a similar pattern across the larger euro area economies over most of the sample period and varied more widely since the start of the sovereign debt crisis in 2010. Focusing on the euro area, we then incorporate the FCI in a VAR model comprising output, inflation, the monetary policy rate, bank loans and bank lending spreads. The credit supply shock extracted with sign restrictions is estimated to have caused around one fifth of the decline in euro area manufacturing production at the trough of the financial crisis and a rise in bank lending spreads of around 30 basis points. We also find that adding the FCI to the VAR enables an earlier detection of credit supply shocks.