Volatility, Growth and Financial Crises

This research group belongs to the IWH Research Cluster Financial Stability and Regulation. Against the backdrop of the latest crisis, the link between financial instability and growth is of particular interest in countries with highly developed financial systems. Financial development may dampen volatility if real sector shocks dominate, but it may also enhance volatility if financial shocks dominate. Thus, occasional financial crises may correspond to stronger long-term growth. However, fundamental mispricing and bubbles on asset markets may also create a link between financial stability and growth working in the opposite direction. Mispricing hampers growth by promoting inefficient allocations. The goal of this group is to explore the relationship between finance and growth by disentangling the fundamental links between financial volatility and macroeconomic dynamics. Thus, this group will contribute to the literature on quantitative macroeconomic models as well as the literature on early-warning tools, strengthening the IWH’s competences in the fields of macroeconomic modelling, forecasting and policy analysis.

IWH Data Project: Financial Stability Indicators in Europe

Research Cluster
Financial Stability and Regulation

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Dr Gregor von Schweinitz
Dr Gregor von Schweinitz
Mitglied - Department Macroeconomics
Send Message +49 345 7753-744

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Refereed Publications

Die Verlustquote bei Handelskreditausfällen – Eine empirische Untersuchung in Deutschland

Henry Dannenberg

in: Zeitschrift für Controlling & Management , No. 2, 2012

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Are Universal Banks Bad for Financial Stability? Germany During the World Financial Crisis

Diemo Dietrich Uwe Vollmer

in: The Quarterly Review of Economics and Finance , No. 2, 2012

Abstract

This case study explores the contribution of universal banking to financial stability in Germany during the recent financial crisis. Germany is a prototype for universal banking and has suffered from a rather small number of banking crises in the past. We review the banking literature and analyze the major institutional and regulatory features of the German financial system to establish a nexus between universal banking and stability.

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Central and Eastern European Countries in the Global Financial Crisis: A Typical Twin Crisis?

Diemo Dietrich Tobias Knedlik Axel Lindner

in: Post-Communist Economies , No. 4, 2011

Abstract

This paper shows that during the Great Recession, banking and currency crises occurred simultaneously in Central and Eastern Europe. Events, however, differed widely from what happened during the Asian crisis that usually serves as the model case for the concept of twin crises. We look at three elements that help explaining the nature of events in Central and Eastern Europe: the problem of currency mismatches, the relation between currency and banking crises, and the importance of multinational banks for financial stability. It is shown that theoretical considerations concerning internal capital markets of multinational banks help understand what happened on capital markets and in the financial sector of the region. We discuss opposing effects of multinational banking on financial stability and find that institutional differences are the key to understand differing effects of the global financial crisis. In particular, we argue that it matters if international activities are organized by subsidiaries or by cross-border financial services, how large the share of foreign currency-denominated credit is and whether the exchange rate is fixed or flexible. Based on these three criteria we give an explanation why the pattern of the crisis in the Baltic States differed markedly from that in Poland and the Czech Republic, the two largest countries of the region.

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Government Interventions in Banking Crises: Effects of Alternative Schemes on Bank Lending and Risk-taking

Diemo Dietrich Achim Hauck

in: Scottish Journal of Political Economy , No. 2, 2012

Abstract

We analyse the effects of policy measures to stop the fall in loan supply following a banking crisis. We apply a dynamic framework in which a debt overhang induces banks to curtail lending or to choose a fragile capital structure. Government assistance conditional on new banking activities, like on new lending or on debt and equity issues, allows banks to influence the scale of the assistance and to externalise risks, implying overinvestment or excessive risk taking or both. Assistance without reference to new activities, like granting lump sum transfers or establishing bad banks, does not generate adverse incentives but may have higher fiscal costs.

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Did the Crisis Affect Potential Output?

Makram El-Shagi

in: Applied Economics Letters , No. 8, 2011

Abstract

Conventional Phillips-curve models that are used to estimate the output gap detect a substantial decline in potential output due to the present crisis. Using a multivariate state space model, we show that this result does not hold if the long run role of excess liquidity (that we estimate endogeneously) for inflation is taken into account.

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Working Papers

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Macroeconomic Trade Effects of Vehicle Currencies: Evidence from 19th Century China

Makram El-Shagi

in: IWH Discussion Papers , No. 23, 2016

Abstract

We use the Chinese experience between 1867 and 1910 to illustrate how the volatility of vehicle currencies affects trade. Today’s widespread vehicle currency is the dollar. However, the macroeconomic effects of this use of the dollar have rarely been addressed. This is partly due to identification problems caused by its international importance. China had adopted a system, where silver was used almost exclusively for trade, similar to a vehicle currency. While being important for China, the global role of silver was marginal, alleviating said identification problems. We develop a bias corrected structural VAR showing that silver price fluctuations significantly affected trade.

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Much Ado About Nothing: Sovereign Ratings and Government Bond Yields in the OECD

Makram El-Shagi

in: IWH Discussion Papers , No. 22, 2016

Abstract

In this paper, we propose a new method to assess the impact of sovereign ratings on sovereign bond yields. We estimate the impulse response of the interest rate, following a change in the rating. Since ratings are ordinal and moreover extremely persistent, it proves difficult to estimate those impulse response functions using a VAR modeling ratings, yields and other macroeconomic indicators. However, given the highly stochastic nature of the precise timing of ratings, we can treat most rating adjustments as shocks. We thus no longer rely on a VAR for shock identification, making the estimation of the corresponding IRFs well suited for so called local projections – that is estimating impulse response functions through a series of separate direct forecasts over different horizons. Yet, the rare occurrence of ratings makes impulse response functions estimated through that procedure highly sensitive to individual observations, resulting in implausibly volatile impulse responses. We propose an augmentation to restrict jointly estimated local projections in a way that produces economically plausible impulse response functions.

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Predicting Financial Crises: The (Statistical) Significance of the Signals Approach

Makram El-Shagi Tobias Knedlik Gregor von Schweinitz

in: IWH Discussion Papers , No. 3, 2012

Abstract

The signals approach as an early warning system has been fairly successful in detecting crises, but it has so far failed to gain popularity in the scientific community because it does not distinguish between randomly achieved in-sample fit and true predictive power. To overcome this obstacle, we test the null hypothesis of no correlation between indicators and crisis probability in three applications of the signals approach to different crisis types. To that end, we propose bootstraps specifically tailored to the characteristics of the respective datasets. We find (1) that previous applications of the signals approach yield economically meaningful and statistically significant results and (2) that composite indicators aggregating information contained in individual indicators add value to the signals approach, even where most individual indicators are not statistically significant on their own.

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Qual VAR Revisited: Good Forecast, Bad Story

Makram El-Shagi Gregor von Schweinitz

in: IWH Discussion Papers , No. 12, 2012

Abstract

Due to the recent financial crisis, the interest in econometric models that allow to incorporate binary variables (such as the occurrence of a crisis) experienced a huge surge. This paper evaluates the performance of the Qual VAR, i.e. a VAR model including a latent variable that governs the behavior of an observable binary variable. While we find that the Qual VAR performs reasonably well in forecasting (outperforming a probit benchmark), there are substantial identification problems. Therefore, when the economic interpretation of the dynamic behavior of the latent variable and the chain of causality matter, the Qual VAR is inadvisable.

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Real Effective Exchange Rate Misalignment in the Euro Area: A Counterfactual Analysis

Makram El-Shagi Axel Lindner Gregor von Schweinitz

in: IWH Discussion Papers , No. 6, 2014

Abstract

Were real effective exchange rates (REER) of Euro area member countries drastically misaligned at the outbreak of the global financial crisis? The answer is difficult to determine because economic theory gives no simple guideline for determining the equilibrium values of real exchange rates, and the determinants of those values might have been distorted as well. To overcome these limitations, we use synthetic matching to construct a counterfactual economy for each member as a linear combination of a large set of non-Euro area countries. We find that Euro area crisis countries are best described by a mixture of advanced and emerging economies. Comparing the actual REER with those of the counterfactuals gives sensible estimates of the misalignments at the start of the crisis: All peripheral countries were strongly overvalued, while high undervaluation is only observed for Finland.

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