Financial Conditions in Europe: Dynamics, Drivers, and Macroeconomic Implications

By Giovanni Borraccia, Raphael A Espinoza, Vincenzo Guzzo, Romain Lafarguette, Fuda Jiang, Vina Nguyen, Miguel A. Segoviano, Philippe Wingender

September 29, 2023

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Giovanni Borraccia, Raphael A Espinoza, Vincenzo Guzzo, Romain Lafarguette, Fuda Jiang, Vina Nguyen, Miguel A. Segoviano, and Philippe Wingender. Financial Conditions in Europe: Dynamics, Drivers, and Macroeconomic Implications, (USA: International Monetary Fund, 2023) accessed December 21, 2024

Disclaimer: IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

Summary

We develop a new measure of financial conditions (FCs) that targets the growth of financial liabilities using the partial least square methodology. We then estimate financial condition indexes (FCIs) across European economies, both at the aggregate and sectoral levels. We decompose the changes in FCs into several factors including credit availability and costs, price of risk, policy stance, and funding constraints. Our results show that FCs loosened during the pandemic thanks to policy support but started to tighten significantly since mid-2021. Using the inverse probability weighting method over the sample period from 2000 to 2023, we find that a shift from a neutral to a tight FCI regime such as the ongoing episode for most European countries will on average lower output and inflation by 2.2 percent and 0.7 percentage points respectively and increase unemployment by 0.3 percentage points over a three-year horizon.

Subject: Asset prices, Credit, Financial cycles, Financial sector policy and analysis, Inflation, Monetary policy, Monetary tightening, Money, Prices

Keywords: Asset prices, Credit, Credit availability and costs, Europe, FCI indicator, FCI regime, Financial condition index, Financial conditions in Europe, Financial cycles, Funding constraints, Global, IMF working paper 2023/209, Inflation, Inverse probability weighting, Measure of financial conditions, Monetary tightening, Partial least square, Policy stance, Price of risk

Publication Details

Pages:

58
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2023/209
Stock No:

WPIEA2023209
ISBN:

9798400254789
ISSN:

1018-5941

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