Financial conditions and economic activity: the potential impact of the targeted long-term refinancing operations (TLTROs)

Abstract

This article explores the relationship between financial conditions and real economic activity in the euro area as a whole and for Greece in particular. We use a financial conditions index (see Angelopoulou et al. 2014) which is constructed using a wide range of prices, quantities, spreads and survey data in line with theory. We update the indices and use them within a VAR framework to estimate the potential impact of the targeted long-term refinancing operations (TLTROs) on aspects of economic activity. Our results suggest that financial conditions do have a significant effect on economic activity, and thus the TLTROs, to the extent that they are designed to improve financial conditions, will provide a boost to the real economy.

KEYWORDS:

• Financial conditions
• monetary policy
• financial crisis
• credit
• nonstandard measures

JEL classification:

• E52
• E51
• E61
• E63
• E65

Notes

¹ This amounts to €400bn for the euro area and €7bn for Greece. This is of course an optimistic assumption, but not a consequential one, as the results of our analysis can readily be scaled down to reflect any degree of pass-through of the TLTRO programme to credit supply.

² These two variables are specified as external in the model because including their dynamics would lead to misspecification. Inflation is one of the variables used in the construction of the FCI, thus its dynamics are already, to some extent, incorporated in the FCI’s dynamic structure. As for the fiscal variable, it reflects unexpected fiscal news, e.g. deviations from forecasts, etc., which, by definition, should have very little serial correlation.

³ The PMI data are provided by Markit Economics, all other data are from Eurostat.

⁴ We only present estimates for the equations where the real variable is the dependent one. A full set of estimates is available from the authors upon request.