Debt-deflation, financial market stress and regime change – Evidence from Europe using MRVAR

Ekkehard Ernst, Willi Semmler and Alexander Haider

Journal of Economic Dynamics and Control, 2017, vol. 81, issue C, 115-139

Abstract: Since the economic meltdown of 2008–2009 many euro area countries have experienced disinflation, and even deflation, in a period with large debt overhang, creating the conditions for continuing financial market stress. As disinflation and deflation push up the real interest rate, while growth and income declines, the leveraging problem becomes more severe and the economy risks shifting into a regime with high insolvency risk, high financial stress, rising credit spreads, possibly accompanied by strong adverse macroeconomic feedback loops. Investigating the consequences of those magnifying feedback loops, given the debt-deflation, we demonstrate the possibility of unstable dynamics and downward spirals in the presence of regime-dependent macro feedback loops, using a theoretical model with decentralized matching mechanisms on both labor and financial markets. To explore the amplifying linkages between deflation, output, labor and financial markets, we employ a new solution procedure called Non-linear Model Predictive Control (NMPC) to solve our models variants for out-of-steady-state dynamics. We apply a four variable Multi-Regime VAR (MRVAR) model with regime dependent (generalized) impulse-response functions (GIRFs) to study deflationary and financial risk drivers empirically for Southern and Northern EU countries. New measures for financial risk drivers are employed and GIRFs for output, inflation rates, interest rates and financial stress are explored. The econometric results of the MRVAR are roughly in line with the theoretical regime change model.

Date: 2017
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (7)

Downloads: (external link)
http://www.sciencedirect.com/science/article/pii/S0165188917300726
Full text for ScienceDirect subscribers only

Related works:
Working Paper: Debt deflation, financial market stress and regime change: Evidence from Europe using MRVAR (2016)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:eee:dyncon:v:81:y:2017:i:c:p:115-139

DOI: 10.1016/j.jedc.2017.03.013

Access Statistics for this article

Journal of Economic Dynamics and Control is currently edited by J. Bullard, C. Chiarella, H. Dawid, C. H. Hommes, P. Klein and C. Otrok

More articles in Journal of Economic Dynamics and Control from Elsevier
Bibliographic data for series maintained by Catherine Liu ().