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The Great Leveraging in the European crisis countries: Domestic credit and net foreign liabilities

Juan Carlos Cuestas (Eesti Pank, Tallinn, Estonia) (Tallinn University of Technology, Tallinn, Estonia)
Karsten Staehr (Eesti Pank, Tallinn, Estonia) (Tallinn University of Technology, Tallinn, Estonia)

Journal of Economic Studies

ISSN: 0144-3585

Article publication date: 13 November 2017

232

Abstract

Purpose

The Great Leveraging was an episode of rapid credit growth and booming housing markets leading up to the global financial crisis. It is important to identify the key drivers of the Great Leveraging and, to this end, the purpose of this paper is to model the relationship between domestic credit and net foreign liabilities in the EU countries most affected by the crisis.

Design/methodology/approach

The analyses show that domestic credit and net foreign liabilities were cointegrated one-to-one for Greece, Italy, Portugal and Spain, while there was no cointegration for Ireland. Estimation of vector error correction models (VECMs) shows that the adjustment to deviations from the cointegrating relationship took place through changes in domestic credit for Greece and Italy, while the adjustment was bidirectional for Spain and maybe also for Portugal.

Findings

These results suggest that external factors in the form of foreign capital inflows were important drivers of the pre-crisis leveraging in the southern crisis countries, although to varying degrees across the countries.

Originality/value

Key novelties include the use of stock variables instead of flow variables and the estimation of VECMs for the countries individually instead of in a panel.

Keywords

Acknowledgements

The authors would like to thank the participants at the ECEE6 Conference in Tallinn, a seminar in Eesti Pank, a "lunch seminar" at INET in New York, the 2015 Conference of the Eastern Economics Association in New York and the IV Meeting on International Economics in Vila-Real for valuable comments. The usual disclaimer applies. Juan Carlos Cuestas acknowledges the financial support from the MINECO Research Grant No. ECO2014-58991-C3-2-R and Generalitat Valenciana Project Grant No. AICO/2016/038. The views expressed are those of the authors and not necessarily those of Eesti Pank.

Citation

Cuestas, J.C. and Staehr, K. (2017), "The Great Leveraging in the European crisis countries: Domestic credit and net foreign liabilities", Journal of Economic Studies, Vol. 44 No. 6, pp. 895-910. https://doi.org/10.1108/JES-12-2016-0268

Publisher

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Emerald Publishing Limited

Copyright © 2017, Emerald Publishing Limited

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