IMF Working Papers

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

Author/Editor:

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

Publication Date:

September 29, 2023

Electronic Access:

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Link to data for this title

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.

Series:

Working Paper No. 2023/209

Subject:

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

Frequency:

regular