European Central Bank

From words to deeds – incorporating climate risks into sovereign credit ratings

07/29/2025 European Central Bank Central banks

We investigate the impact of climate risks on sovereign credit ratings worldwide. Our analysis shows that higher temperature anomalies and more frequent natural disasters – measures of physical risk – correlate with lower credit ratings. We find that long-term shifts in climate patterns (“chronic risk”) primarily affect advanced economies, while the increased frequency and severity of extreme weather events (“acute risk”) matters more for emerging economies. However, the estimated impact of both types of risk on credit ratings is low and the economic effects are negligible.

Climate change, firms and aggregate productivity

06/24/2025 European Central Bank Central banks

Our paper uses a general equilibrium framework to examine the effects of temperature on firm-level demand, productivity and input allocative efficiency. Using data from Italian firms and detailed climate data, it uncovers a sizeable negative effect of extreme temperatures on firm-level productivity. Based on these estimates, the model generates aggregate productivity losses from local temperature fluctuations that are higher than previously thought, ranging from 0.60% to 6.82% depending on the scenario and the extent of adaptation.

Private safe asset supply and financial instability

05/27/2025 European Central Bank Central banks

This article studies the supply of private safe assets by banks and its implications for financial stability. Banks originate loans and improve loan quality through hidden screening efforts. They can then create safe assets by issuing debt backed by the safe payoffs, from both loans they have originated and a diversified pool of loans from other banks. The interaction between banks’ screening efforts and diversification decisions determines the volume of safe assets they supply.

Why monetary policy should crack down harder during high inflation

04/29/2025 European Central Bank Central banks

The recent surge in inflation has led to a significant increase in the frequency of price changes, making prices more flexible. Conventional models assume a constant price change frequency, but in state-dependent models the frequency varies with economic conditions. Price flexibility has an impact on the effectiveness of monetary policy. In high inflation periods, frequent price changes make monetary policy more effective in reducing inflation with less impact on economic activity. Therefore, monetary policy should be more aggressive during such periods to stabilise prices efficiently.

Effects of monetary policy on labour income: the role of the employer

03/26/2025 European Central Bank Central banks

This article investigates how firms transmit monetary policy shocks to individual labour market outcomes at both the intensive and extensive margins. Using matched employer-employee administrative data from Germany, we study the effects of monetary policy shocks on individual employment and of labour income conditioning on characteristics of workers and firms. First, we find that the employment of workers at young firms is especially sensitive to monetary policy shocks.

Critical input disruptions – mapping out the road to EU resilience

02/24/2025 European Central Bank Central banks

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

How tightening mortgage credit raises rents and increases inequality in the housing market

01/16/2025 European Central Bank Central banks

Housing affordability is at the centre of the political debate in many euro area countries. With steadily increasing rents and house prices still high relative to historical standards, many young households, particularly in large cities, are devoting an ever larger share of their income to housing expenses, and are finding it increasingly hard to access their desired size and quality of housing.

The “doom loop” and default incentives

12/16/2024 European Central Bank Central banks

The “doom loop” or “sovereign-bank nexus” has been a key factor in the European debt crisis, driven by feedback between fiscal sustainability risks and financial stability. This Research Bulletin revisits the doom loop, examining strategic default incentives and the unintended effects of policy interventions. While limiting banks’ exposure to sovereign debt can break the doom loop, it may increase default risks by weakening governments’ repayment incentives.

The macroeconomic effects of liquidity supply during financial crises

11/28/2024 European Central Bank Central banks

Negative economic shocks can cause waves of investor pessimism about the resilience of banks, which, in turn, generate additional adverse macroeconomic effects. This is commonly cited as an explanation for the economic havoc wrought by the global financial crisis of 2007-08. We introduce the notion of pessimism in a real business cycle model, which is a standard framework for business cycle analysis. The possibility of waves of pessimism generates countercyclical demand from banks for liquid assets (e.g., bank reserves).

Banks lose – someone gains: Households’ unequal exposure to financial distress

10/30/2024 European Central Bank Central banks

Is the burden of distress in the banking sector shared equally among households, or is it distributed unevenly? Following the global financial crisis, the economic consequences of severe disruptions to the banking sector and the unequal impact of recessions have become a key concern of macroeconomic policy. This article examines how temporary banking sector losses affect households differently according to their income levels. The analysis reveals that low-income households bear most of the burden, while high-income households tend to be less adversely affected.

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