Working Paper: CEPR ID: DP9957
Authors: Jan in 't Veld; Robert Kollmann; Beatrice Pataracchia; Marco Ratto; Werner Roeger
Abstract: We study the joint dynamics of foreign capital flows and real activity during the recent boom-bust cycle of the Spanish economy, using a three-country New Keynesian model with credit constrained households and firms, a construction sector and a government. We estimate the model using 1995Q1-2013Q2 data for Spain, the rest of the Euro Area (REA) and the rest of the world. We show that falling risk premia on Spanish housing and non-residential capital, a loosening of collateral constraints for Spanish households and firms, as well as a fall in the interest rate spread between Spain and the REA fuelled the Spanish output boom and the persistent rise in foreign capital flows to Spain, before the global financial crisis. During and after the global financial crisis, falling house prices, and a tightening of collateral constraints for Spanish borrowers contributed to a sharp reduction in capital inflows, and to the persistent slump in Spanish real activity. The credit crunch was especially pronounced for Spanish households; firm credit constraints tightened later and more gradually, and contributed much less to the slump.
Keywords: boom-bust cycle; European Monetary Union; financial frictions; housing market; international capital flows; Spain; sudden stop
JEL Codes: C11; E21; E32; E62
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| decrease in risk premia on Spanish housing and non-residential capital (G59) | boom in output (E32) |
| loosening of collateral constraints (G33) | boom in output (E32) |
| decrease in risk premia on Spanish housing and non-residential capital (G59) | increase in foreign capital inflows to Spain (F21) |
| loosening of collateral constraints (G33) | increase in foreign capital inflows to Spain (F21) |
| convergence of Spanish interest rates to lower rates in REA (E43) | increased investment (E22) |
| convergence of Spanish interest rates to lower rates in REA (E43) | enhanced housing prices (R31) |
| falling house prices (R31) | reduction in capital inflows (F32) |
| tightening collateral constraints (F65) | reduction in capital inflows (F32) |
| tightening collateral constraints (F65) | persistent slump in real activity (E32) |
| credit crunch (E51) | severe reduction in capital inflows (F32) |
| severe reduction in capital inflows (F32) | persistent slump in real activity (E32) |
| joint dynamics of financial shocks (E32) | driving boom and subsequent bust in Spanish economic activity (E32) |