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17 June 2016

ECB: A macroeconomic model of banking and financial interdependence in the euro area


Results support that the business cycles can be driven not only by real shocks, but also by financial shocks, the financial sector can amplify the transmission of (real) shocks, and the financial/banking shocks and the banking sectors can be sources of business cycle asymmetries and spillovers.

The recent financial crisis, which has resulted in a long period of economic stagnation and extremely low inflation, especially in the euro area (EA), and the ensuing debate on policy responses (in particular by central banks) have widely increased the need for understanding how domestic and cross-country financial factors might affect macroeconomic performance in a monetary union such as the EA. Heterogeneous conditions in financial markets and banking sectors within the union can make it difficult for a common monetary policy to guarantee the union-wide macroeconomic stability, while calling for macroprudential policies to foster financial stability at a country and, hence, union level. Understanding the role of country-specific structural financial and banking features, their interaction within and across regions and their effect on the transmission mechanism of monetary policy is crucial for a proper analysis of monetary and financial stabilization issues in a monetary union, and in particular for a thorough assessment of policy responses in the EA in the aftermath of the recent financial crisis.

To tackle these issues authors enrich a multi-country model of the EA called EAGLE (Euro Area and GLobal Economy) model (see Gomes, Jacquinot and Pisani 2010, 2012) with financial frictions, banking sectors and a cross-country interbank market. This paper describes the new setup, labeled EAGLE-FLI (Euro Area and GLobal Economy with Financial LInkages), and its usefulness from a policy perspective via a set of simulations, that shows the macroeconomic effects of (several) financial shocks.

Their results aim at explaining the transmission mechanism of various shocks in a model environment where financial factors do matter. Even though the analysis does not aim to quantitatively explain neither the EA business cycle nor the recent financial crisis, the results support the views that

  • the business cycles in the EA can be driven not only by real shocks, but also by financial shocks,
  • the financial sector can amplify the transmission of (real) shocks, and
  • the financial/banking shocks and the banking sectors can be sources of business cycle asymmetries and spillovers across countries in a monetary union.

Working paper



© ECB - European Central Bank


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