Financial institutions

Using structural models to understand macroeconomic tail risks

10/21/2024 European Central Bank Central banks

Understanding asymmetric risks in macroeconomic variables is challenging. Most structural models used for policy analysis are linearised and therefore cannot generate asymmetries such as those documented in the empirical growth-at-risk (GaR) literature. This report examines how structural models can incorporate non-linearities to generate tail risks. The first part reviews the various extensions to dynamic stochastic general equilibrium (DSGE) models and the computational challenges involved in accounting for risk distributions.

Variational inference for Bayesian panel VAR models

10/21/2024 European Central Bank Central banks

We study the application of approximate mean field variational inference algorithms to Bayesian panel VAR models in which an exchangeable prior is placed on the dynamic parameters and the residuals follow either a Gaussian or a Student-t distribution. This reduces the estimation time of possibly several hours using conventional MCMC methods to less than a minute using variational inference algorithms. Next to considerable speed improvements, our results show that the approximations accurately capture the dynamic effects of macroeconomic shocks as well as overall parameter uncertainty.

Inputs in distress: geoeconomic fragmentation and firms’ sourcing

10/21/2024 European Central Bank Central banks

We study how disruptions to the supply of foreign critical inputs (FCIs) —that is, inputs primarily sourced from extra-EU countries with highly concentrated supply, advanced technology products, or which are key to the green transition —might affect value added at different levels of aggregation. Using firm-level customs and balance sheet data for Belgium, France, Italy, Slovenia and Spain, our framework allows us to assess how much geoeconomic fragmentation might affect European economies differently.

Variational inference for Bayesian panel VAR models

10/21/2024 European Central Bank Central banks

We study the application of approximate mean field variational inference algorithms to Bayesian panel VAR models in which an exchangeable prior is placed on the dynamic parameters and the residuals follow either a Gaussian or a Student-t distribution. This reduces the estimation time of possibly several hours using conventional MCMC methods to less than a minute using variational inference algorithms. Next to considerable speed improvements, our results show that the approximations accurately capture the dynamic effects of macroeconomic shocks as well as overall parameter uncertainty.

Inputs in distress: geoeconomic fragmentation and firms’ sourcing

10/21/2024 European Central Bank Central banks

We study how disruptions to the supply of foreign critical inputs (FCIs) —that is, inputs primarily sourced from extra-EU countries with highly concentrated supply, advanced technology products, or which are key to the green transition —might affect value added at different levels of aggregation. Using firm-level customs and balance sheet data for Belgium, France, Italy, Slovenia and Spain, our framework allows us to assess how much geoeconomic fragmentation might affect European economies differently.

Monetary policy and growth-at-risk: the role of institutional quality

10/18/2024 European Central Bank Central banks

This paper analyses how country-specific institutional quality shapes the impact of monetary policy on downside risks to GDP growth in the euro area. Using identified high-frequency shocks in a growth-at-risk framework, we show that monetary policy has a higher impact on downside risks in the short term than in the medium term. However, this result for the euro area average hides significant heterogeneity across countries. In economies with weak institutional quality, medium-term growth risks increase substantially following contractionary monetary policy shocks.

Monetary policy and growth-at-risk: the role of institutional quality

10/18/2024 European Central Bank Central banks

This paper analyses how country-specific institutional quality shapes the impact of monetary policy on downside risks to GDP growth in the euro area. Using identified high-frequency shocks in a growth-at-risk framework, we show that monetary policy has a higher impact on downside risks in the short term than in the medium term. However, this result for the euro area average hides significant heterogeneity across countries. In economies with weak institutional quality, medium-term growth risks increase substantially following contractionary monetary policy shocks.

Climate capitalists

10/18/2024 European Central Bank Central banks

Firms’ perceived cost of green capital has decreased since the rise of sustainable investing. Green and brown firms perceived their cost of capital to be the same before 2016, but after the post-2016 surge in sustainable investing, green firms perceived their cost of capital to be on average 1 percentage point lower. This difference has widened as sustainable investing has intensified. Within some of the largest energy and utility firms, managers have started applying a lower cost of capital to greener divisions.

Climate capitalists

10/18/2024 European Central Bank Central banks

Firms’ perceived cost of green capital has decreased since the rise of sustainable investing. Green and brown firms perceived their cost of capital to be the same before 2016, but after the post-2016 surge in sustainable investing, green firms perceived their cost of capital to be on average 1 percentage point lower. This difference has widened as sustainable investing has intensified. Within some of the largest energy and utility firms, managers have started applying a lower cost of capital to greener divisions.

Main findings from the ECB’s recent contacts with non-financial companies

10/18/2024 European Central Bank Central banks

This box summarises the findings of recent contacts between ECB staff and representatives of 95 leading non-financial companies operating in the euro area. According to these exchanges, which took place between 16 and 26 September 2024, business momentum slowed somewhat over the summer, mainly as a result of declining confidence in the industrial sector, causing firms to scale back investment and focus on cost cutting. Meanwhile, the anticipated recovery in consumer spending was still rather patchy.

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