Recurring financial instabilities have led policymakers to rely on early-warning models to signal financial vulnerabilities. These models rely on ex-post optimization of signaling thresholds on crisis probabilities accounting for preferences between forecast errors, but come with the crucial drawback of unstable thresholds in recursive estimations. We propose two alternatives for threshold setting with similar or better out-of-sample performance: (i) including preferences in the estimation itself and (ii) setting thresholds ex-ante according to preferences only. Given probabilistic model output, it is intuitive that a decision rule is independent of the data or model specification, as thresholds on probabilities represent a willingness to issue a false alarm vis-à-vis missing a crisis. We provide real-world and simulation evidence that this simplification results in stable thresholds, while keeping or improving on out-of-sample performance. Our solution is not restricted to binary-choice models, but directly transferable to the signaling approach and all probabilistic early-warning models.

Can a negative shock to sovereign ratings invoke a vicious cycle of increasing government bond yields and further downgrades, ultimately pushing a country toward default? The narratives of public and political discussions, as well as of some widely cited papers, suggest this possibility. In this paper, we will investigate the possible existence of such a vicious cycle. We find no evidence of a bad long-run equilibrium and cannot confirm a feedback loop leading into default as a transitory state for all but the very worst ratings. We use a bivariate semiparametric dynamic panel model to reproduce the joint dynamics of sovereign ratings and government bond yields. The individual equations resemble Pesaran-type cointegration models, which allow for valid interference regardless of whether the employed variables display unit-root behavior. To incorporate most of the empirical features previously documented (separately) in the literature, we allow for different long-run relationships in both equations, nonlinearities in the level effects of ratings, and asymmetric effects in changes of ratings and yields. Our finding of a single good equilibrium implies the slow convergence of ratings and yields toward this equilibrium. However, the persistence of ratings is sufficiently high that a rating shock can have substantial costs if it occurs at a highly speculative rating or lower. Rating shocks that drive the rating below this threshold can increase the interest rate sharply, and for a long time. Yet, simulation studies based on our estimations show that it is highly improbable that rating agencies can be made responsible for the most dramatic spikes in interest rates.

The European debt crisis has revealed severe imbalances within the Euro area, sparking a debate about the magnitude of those imbalances, in particular concerning real effective exchange rate misalignments. We use synthetic matching to construct a counterfactual economy for each member state in order to identify the degree of these misalignments. We find that crisis countries are best described as a combination of advanced and emerging economies. Comparing the actual real effective exchange rate with those of the counterfactuals gives evidence of misalignments before the outbreak of the crisis: all peripheral countries appear strongly and significantly overvalued.

This article applies an adjusted growth diagnostic approach to identify the currently most binding constraint on financing growth in the West Balkan countries. Since this group of economies faces both structural and systemic transformation problems, the original supply-side approach might not be sufficient to detect the most binding constraint. The results of the analysis indicate that the binding constraint on credit and investment growth in the region is the high and increasing share of nonperforming loans, primarily in the household sector, due to policy failures. This article compares the Balkan countries to a group of advanced transition economies. Single-country and panel regressions indicate that demand-side factors do not play a constraining role on growth in the West Balkan countries, but they do in the advanced transition economies.

After every major financial crisis, the question about the responsibility of the rating agencies resurfaces. Regarding government bonds, the most frequently voiced concern targeted “unreasonably” bad ratings that might trigger capital flights and increasing risk premia which sanction further rating downgrades. In this paper we develop a multivariate, nonparametric version of the Pesaran type cointegration model that allows for nonlinearities, to show that a unique equilibrium between ratings and sovereign yields exists. Therefore, we have to reject the concern that there is an unholy cycle leading to certain default in the long run.

This paper compares the out-of-sample predictive performance of different early warning models for systemic banking crises using a sample of advanced economies covering the past 45 years. We compare a benchmark logit approach to several machine learning approaches recently proposed in the literature. We find that while machine learning methods often attain a very high in-sample fit, they are outperformed by the logit approach in recursive out-of-sample evaluations. This result is robust to the choice of performance measure, crisis definition, preference parameter, and sample length, as well as to using different sets of variables and data transformations. Thus, our paper suggests that further enhancements to machine learning early warning models are needed before they are able to offer a substantial value-added for predicting systemic banking crises. Conventional logit models appear to use the available information already fairly effciently, and would for instance have been able to predict the 2007/2008 financial crisis out-of-sample for many countries. In line with economic intuition, these models identify credit expansions, asset price booms and external imbalances as key predictors of systemic banking crises.

The Swiss National Bank abolished the exchange rate floor versus the Euro in January 2015. Based on a synthetic matching framework, we analyse the impact of this unexpected (and therefore exogenous) shock on the stock market. The results reveal a significant level shift (decline) in asset prices in Switzerland following the discontinuation of the minimum exchange rate. While adjustments in stock market returns were most pronounced directly after the news announcement, the variance was elevated for some weeks, indicating signs of increased uncertainty and potentially negative consequences for the real economy.

Reserve requirements, as a tool of macroprudential policy, have been increasingly employed since the outbreak of the great financial crisis. We conduct an analysis of the effect of reserve requirements in tranquil and crisis times on credit and GDP growth making use of Bayesian model averaging methods. In terms of credit growth, we can show that initial negative effects of higher reserve requirements (which are often reported in the literature) tend to be short-lived and turn positive in the longer run. In terms of GDP per capita growth, we find on average a negative but not robust effect of regulation in tranquil times, which is only partly offset by a positive but also not robust effect in crisis times.

In this paper, we investigate to what extent sovereign stress and banking stress have contributed to the increase in the level and in the heterogeneity of non-financial firms’ financing costs in the Euro area during the European debt crisis and how both have affected the monetary transmission mechanism. Employing a large firm-level data set containing two million observations, we are able to identify the effect of government bond yield spreads (sovereign stress) and the share of non-performing loans (banking stress) on firms‘ financing costs in a panel model by assuming that idiosyncratic shocks to individual firms are uncorrelated with country-specific variables. We find that the two sources of stress have increased firms’ financing costs controlling for country and firm-specific factors. Moreover, we estimate both to have significantly impaired the monetary transmission mechanism.

We investigate drivers of Euro area inflation dynamics using a panel of regional Phillips curves and identify long-run inflation expectations by exploiting the crosssectional dimension of the data. Our approach simultaneously allows for the inclusion of country-specific inflation and unemployment-gaps, as well as time-varying parameters. Our preferred panel specification outperforms various aggregate, uni- and multivariate unobserved component models in terms of forecast accuracy. We find that declining long-run trend inflation expectations and rising inflation persistence indicate an altered risk of inflation expectations de-anchoring. Lower trend inflation, and persistently negative unemployment-gaps, a slightly increasing Phillips curve slope and the downward pressure of low oil prices mainly explain the low inflation rate during the recent years.