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The Great (De)leveraging in the 
GIIPS countries. Foreign liabilities 
and private credit 1998-2013 
Eesti Pank seminar, 3...
Little introduction, who am I? 
• Name: Juan Carlos Cuestas Olivares 
• Citizenship: Spanish/British 
• Age: Unknown 
• We...
Stylised facts 
• Pre-crisis: 
– Low interest rates in industrialised countries. 
– Savings glut. 
– International investo...
4 
140 
120 
100 
80 
60 
40 
20 
CR_GR 
98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 
100 
90 
80 
70 
60 
50 
CR_IT 
...
5 
120 
100 
80 
60 
40 
20 
NFL_GR 
98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 
32 
28 
24 
20 
16 
12 
8 
4 
NFL_IT...
Stylised facts (cont’d) 
Big question: 
What is relation between credit expansion and 
capital inflows? 
• Global Financia...
Structure of the presentation 
• Introduction/motivation 
• Brief literature review 
• Data and graphs 
• Method and resul...
Introduction 
• We’ve observed less restrictions to international capital flows since 
the 80s. + introduction of the € wh...
Introduction (cont’d) 
• Exposed countries experience large CA deficits, increasing their 
exposure to international shock...
Introduction (cont’d) 
Capital inflows Credit expansion 
10
Introduction (cont’d) 
• We are not concerned about the final sector of destination, but 
about the effect on the overall ...
Introduction (cont’d) 
• Is there a theoretical connection between capital inflow and credit 
creation? 
• Yes, there is. ...
Brief literature review 
• Lane and Milesi-Ferretti (2008): analyse the level of foreign assets 
as a function of amongst ...
Brief literature review (cont’d) 
• Jordá et al. (2013): analyse the effect on real GDP per capita 
of excess credit pre r...
Brief literature review (cont’d) 
• Issues: 
– Δca and Δcr ~ I(0), miss long-run 
– ca and cr ~ I(1), cointegration, but i...
Data and graphs 
• This analysis uses quarterly data for the GIIPS for credit from 
banks to private sector/GDP, (cr) and ...
17 
.8 
.7 
.6 
.5 
.4 
.3 
.2 
.28 .32 .36 .40 .44 .48 .52 .56 .60 .64 .68 .72 .76 .80 
L1CR_GR 
L1NFL_GR 
2007:4 
.8 
.7...
18 
NFL = Net Foreign Liabilities = – Net International Investment Position 
NFL (t – 1) Financial account (t) 
+ + + = 
+...
Method and results 
19 
  
t t i X  X   X    
t i t 
p 
i 
 
1 
1 
Δ푙1푐푟푡 = 휇1 + 훼1 푙1푐푟푡−1 − 훽푙1푛푓푙푡−1 + ...
Method and results 
 1 
t t i X  X   X    
Steps in the Johansen method: 
• Test for unit roots, since at l...
21 
Augmented Dickey-Fuller test 
L1NFL L1CR 
Country-period t-Statistic p-value t-Statistic p-value 
Greece-full -1.53384...
22 
Cointegration tests 
Country-period No. of CE(s) 
Trace 
statistic 
0.05 critical 
value 
p-valuea) 
Max-eigen-value 
...
23 
Cointegration vector full sample 
Cointegrating Eq: Greece Italy Portugal Spain 
L1CR(-1) 1.000000 1.000000 1.000000 1...
24 
Adjustment parameters of Error Correction Term (ECT) 
Greece Italy Portugal Spain 
D(L1CR) D(L1NFL) D(L1CR) D(L1NFL) D...
25
26
27
28
Mini conclusions 
• Set up the analysis of capital flows and credit expansion 
• Theoretical reasons to analyse cr and nfl...
Comments?? 
Tänan väga 
30
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Juan Carlos Cuestas. The Great (De)leveraging in the GIIPS countries. Foreign liabilities and private credit 1998-2013

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Eesti Pank seminar, 30th June 2014

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Juan Carlos Cuestas. The Great (De)leveraging in the GIIPS countries. Foreign liabilities and private credit 1998-2013

  1. 1. The Great (De)leveraging in the GIIPS countries. Foreign liabilities and private credit 1998-2013 Eesti Pank seminar, 30th June 2014 Juan Carlos Cuestas (Visiting researcher Eesti Pank, University of Sheffield) Karsten Staehr (Eesti Pank, Tallinn Technical University) All views expressed here are personal. Preliminary work, please do not quote
  2. 2. Little introduction, who am I? • Name: Juan Carlos Cuestas Olivares • Citizenship: Spanish/British • Age: Unknown • Weight: Even more unknown • Height: 176 cm (-2cm Spanish average, -3cm Estonian average) • Current position: Senior Lecturer (associate professor), University of Sheffield and last day as a visiting researcher, Eesti Pank • PhD from Jaume I University (Spain) in 2005 • Keen on applied macroeconometrics and international finance • Website: http://jccuestas.me.uk 2
  3. 3. Stylised facts • Pre-crisis: – Low interest rates in industrialised countries. – Savings glut. – International investors more willing to take higher risks. – Money flowing to less developed economies, amongst them peripheral European countries. – Boom-ing (or rather bombing) global economy, huge domestic credit expansion. 3
  4. 4. 4 140 120 100 80 60 40 20 CR_GR 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 100 90 80 70 60 50 CR_IT 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 00 01 02 03 04 05 06 07 08 09 10 11 12 13 180 160 140 120 100 80 60 CR_PT 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 180 160 140 120 100 80 60 CR_ES 200 180 160 140 120 100 80 60 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 CR_IE
  5. 5. 5 120 100 80 60 40 20 NFL_GR 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 32 28 24 20 16 12 8 4 NFL_IT 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 100 90 80 70 60 50 40 30 20 140 120 100 80 60 40 20 NFL_ES NFL_IE 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 140 120 100 80 60 40 20 NFL_PT 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 0 00 01 02 03 04 05 06 07 08 09 10 11 12 13
  6. 6. Stylised facts (cont’d) Big question: What is relation between credit expansion and capital inflows? • Global Financial Crisis ignition: BIG CRISIS!!!  • Need to understand: – Linkages between finance and macroeconomic developments. – Linkages between domestic and cross-border finance. 6
  7. 7. Structure of the presentation • Introduction/motivation • Brief literature review • Data and graphs • Method and results • Mini conclusions • Comments, discussion, complaints  7
  8. 8. Introduction • We’ve observed less restrictions to international capital flows since the 80s. + introduction of the € which reduces international investment risks + the need to invest in more profitable/riskier sectors/investments. • Have capital inflows been a “bad boy”? – Capital inflow / current account deficit  interest rate ↓ / borrowing possibility  demand ↑  boom. – On the other hand: excessive credit expansions, concentration of production on small number of sector and distortion of prices. – Contractionary monetary policy (if any) may become ineffective. • Sudden stops of capital inflows + Fisher’s debt deflation channel. 8
  9. 9. Introduction (cont’d) • Exposed countries experience large CA deficits, increasing their exposure to international shocks. – increased risk perception of these countries. – High leverage may increase the risk of mismatches between borrowing and investment (“hot money” invested in long run projects). • Obstfeld (2012) says that CA deficits could be a potential indicator of internal macroeconomic weakness. 9
  10. 10. Introduction (cont’d) Capital inflows Credit expansion 10
  11. 11. Introduction (cont’d) • We are not concerned about the final sector of destination, but about the effect on the overall credit expansion in the receiving economy + the direction of causality. • Push factors vs pull factors. • Hypotheses: H1: Capital flows have a significant impact on the overall credit creation in the receiving country. H2: credit creation needs foreign capital to keep the booming economy. 11
  12. 12. Introduction (cont’d) • Is there a theoretical connection between capital inflow and credit creation? • Yes, there is. Carvalho (2004) nails both stories nicely M = C + D (liabilities side definition) M = DCNBS + NFA + ODA – LFL (assets side definition) 12
  13. 13. Brief literature review • Lane and Milesi-Ferretti (2008): analyse the level of foreign assets as a function of amongst others, GDP per capita and ca-openness. • Lane and Milesi-Ferretti (2010): analyse whether the cross-country incidence and severity of the crisis is related to pre-crisis macro and finance factors. • Reinhart and Reinhart (2008): sudden stops and its effects on the receiving economies. • Avdijev et al. (2012): analyse the impact of financial openness, economic size and FX volatility on the change of credit/GDP. (Asia) • Reinhart and Vesperoni (2012) look at the reaction of domestic credit/GDP as to capital inflows, XR regime, money growth etc. 13
  14. 14. Brief literature review (cont’d) • Jordá et al. (2013): analyse the effect on real GDP per capita of excess credit pre recession. (cross-section) • Taylor (2013) is concerned about the change in credit/GDP as a function of changes in ca/GDP. • Carvalho (2014) cross section for different averages, looking at flows of capital on credit and money • Veld et al. (2014): Analysis for Spain’s housing market 14
  15. 15. Brief literature review (cont’d) • Issues: – Δca and Δcr ~ I(0), miss long-run – ca and cr ~ I(1), cointegration, but interpretation? – Δnfl or ca and Δcr ~ I(0), miss long-run – nfl and cr ~ I(1), THIS IS THE ONE!! • Our specification: VAR/VECM (푐푟, 푛푓푙) 푐표푖푛푡푒푔푟푎푡푖표푛? ? adjustment?? 15
  16. 16. Data and graphs • This analysis uses quarterly data for the GIIPS for credit from banks to private sector/GDP, (cr) and net foreign liabilities/GDP (nfl) • Databases: Eurostat, BIS. – Span of data 1998:4-2013:3 – Ireland 2000:4-2013:4 • L1NFL = log(1 + NFL) • L1CR = log(1 + CR) 16
  17. 17. 17 .8 .7 .6 .5 .4 .3 .2 .28 .32 .36 .40 .44 .48 .52 .56 .60 .64 .68 .72 .76 .80 L1CR_GR L1NFL_GR 2007:4 .8 .7 .6 .5 .4 .3 .2 .1 .0 0.55 0.60 0.65 0.70 0.75 0.80 0.85 0.90 0.95 1.00 1.05 1.10 L1CR_IE L1NFL_IE 2007:4 .28 .24 .20 .16 .12 .08 .04 .42 .44 .46 .48 .50 .52 .54 .56 .58 .60 .62 .64 .66 .68 L1CR_IT L1NFL_IT 2007:4 .8 .7 .6 .5 .4 .3 .2 .1 0.55 0.60 0.65 0.70 0.75 0.80 0.85 0.90 0.95 1.00 L1CR_PT L1NFL_PT 2007:4 .7 .6 .5 .4 .3 .2 0.50 0.55 0.60 0.65 0.70 0.75 0.80 0.85 0.90 0.95 1.00 1.05 L1CR_ES L1NFL_ES 2007:4
  18. 18. 18 NFL = Net Foreign Liabilities = – Net International Investment Position NFL (t – 1) Financial account (t) + + + = + + + + Change in official reserves (t) = 1) Valuation changes (t) NFL (t) Capital account (t) 1) Errors and omissions (t) Current account balance (t) 0
  19. 19. Method and results 19   t t i X  X   X    t i t p i  1 1 Δ푙1푐푟푡 = 휇1 + 훼1 푙1푐푟푡−1 − 훽푙1푛푓푙푡−1 + 푝 푖=1 훾11(푖)Δ푙1푐푟푡−푖 + 푝 푖=1 훾12(푖)Δ푙1푛푓푙푡−푖 + 휀1푡 Δ푙1푛푓푙푡 = 휇2 + 훼2 푙1푐푟푡−1 − 훽푙1푛푓푙푡−1 + 푝 푖=1 훾21(푖)Δ푙1푐푟푡−푖 + 푝 푖=1 훾22(푖)Δ푙1푛푓푙푡−푖 + 휀2푡
  20. 20. Method and results  1 t t i X  X   X    Steps in the Johansen method: • Test for unit roots, since at least two of the variables need to be I(1) processes • Misspecification tests and lag length selection • Rank test, for the number of cointegration vectors, max n-1 cointegrating vectors • Estimation of the restricted model, i.e. identification of the cointegration space • Stability 20 t i t p i  1
  21. 21. 21 Augmented Dickey-Fuller test L1NFL L1CR Country-period t-Statistic p-value t-Statistic p-value Greece-full -1.533847 0.5097 -2.017650 0.2786 Greece-pre’08 2.658311 0.9999 1.9447208 0.9998 Greece-post’08 -1.250382 0.6341 -2.366735 0.1614 Ireland-full -1.067586 0.7218 -1.457032 0.5472 Ireland-pre’08 -2.493829 0.1272 0.461843 0.9822 Ireland-post’08 -3.378249 0.0227a -0.253291 0.9179 Italy-full -1.363708 0.5932 -1.540276 0.5058 Italy-pre’08 1.106011 0.9967 1.975874 0.9998 Italy-post’08 -2.853174 0.0666 -2.316202 0.1755 Portugal-full -2.056691 0.2626 -1.383531 0.5836 Portugal-pre’08 -1.559765 0.4921 -3.145626 0.0320b Portugal-post’08 -1.493430 0.5189 -0.874522 0.7777 Spain-full -0.357813 0.9091 -1.507840 0.5226 Spain-pre’08 1.839332 0.9997 1.087170 0.9966 Spain-post’08 -1.651234 0.4415 -0.037465 0.9454 Note: Rejection of the null hypothesis of a unit root at the 5% in bold. Lag length obtained by the modified Akaike Information Criterion. a This result is confirmed by the Phillips-Perron test. Results available upon request. b The Phillips-Perron test cannot reject the null of unit root. This result is confirmed by the KPSS test for stationarity. Results available upon request. Hence we proceed under the assumption that the variable is an I(1) process.
  22. 22. 22 Cointegration tests Country-period No. of CE(s) Trace statistic 0.05 critical value p-valuea) Max-eigen-value 0.05 critical value p-valuea) Greece-Full None 17.921 15.49471 0.0211 16.00725 14.26460 0.0263 At most 1 1.9137 3.841466 0.1665 1.913739 3.841466 0.1665 Greece-pre’08 None 26.270 15.49471 0.0008 25.46771 14.26460 0.0006 At most 1 0.802 3.841466 0.3705 0.801844 3.841466 0.3705 Greece-post’08 None 19.650 15.49471 0.0111 12.92659 14.26460 0.0805 At most 1 6.724 3.841466 0.0095 6.723608 3.841466 0.0095 Ireland-Full None 10.961 15.49471 0.2139 7.898157 14.26460 0.3891 At most 1 3.063 3.841466 0.0801 3.062512 3.841466 0.0801 Ireland-pre’08 None 36.690 15.49471 0.0000 36.58958 14.26460 0.0000 At most 1 0.101 3.841466 0.7501 0.101420 3.841466 0.7501 Italy-Full None 18.152 15.49471 0.0194 16.71929 14.26460 0.0201 At most 1 1.432 3.841466 0.2314 1.432402 3.841466 0.2314 Italy-pre’08 None 19.075 15.49471 0.0138 14.03695 14.26460 0.0543 At most 1 5.038 3.841466 0.0248 5.038362 3.841466 0.0248 Italy-post’08 None 17.974 15.49471 0.0207 13.54807 14.26460 0.0646 At most 1 4.426 3.841466 0.0354 4.426282 3.841466 0.0354 Portugal-Full None 14.766 12.32090 0.0191 13.57260 11.22480 0.0190 At most 1 1.1939 4.129906 0.3202 1.193860 4.129906 0.3202 Portugal-pre’08 None 16.915 15.49471 0.0304 14.43122 14.26460 0.0471 At most 1 2.484 3.841466 0.1150 2.483665 3.841466 0.1150 Portugal-post’08 None 30.594 15.49471 0.0001 26.80671 14.26460 0.0003 At most 1 3.787 3.841466 0.0516 3.787351 3.841466 0.0516 Spain-Full None 14.198 15.49471 0.0777 14.04360 14.26460 0.0541 At most 1 0.154 3.841466 0.6943 0.154424 3.841466 0.6943 Spain-pre’08 None 21.377 15.49471 0.0058 16.86027 14.26460 0.0190 At most 1 4.517 3.841466 0.0335 4.517182 3.841466 0.0335 Spain-post’08 None 14.140 15.49471 0.0792 14.01847 14.26460 0.0546 At most 1 0.122 3.841466 0.7273 0.121569 3.841466 0.7273 a) MacKinnon-Haug-Michelis (1999) p-values. Data for Ireland starts in 2000:4.
  23. 23. 23 Cointegration vector full sample Cointegrating Eq: Greece Italy Portugal Spain L1CR(-1) 1.000000 1.000000 1.000000 1.000000 L1NFL(-1) -1.158486 -1.055730 -0.884030 -0.889948 [-18.0053] [-13.4315] [-6.19853] [-10.5795] C 0.063333 -0.382137 - -0.399525 Cointegration vector pre’08 Cointegrating Eq: Greece Italy Portugal Spain L1CR(-1) 1.000000 1.000000 1.000000 1.000000 L1NFL(-1) -0.898460 -1.289770 -1.141753 -1.281070 [-36.7244] [-7.64582] [-5.13698] [-6.03797] C -0.035412 -0.337444 -0.241992 -0.238181 Cointegration vector post’08 Cointegrating Eq: Greece Italy Portugal Spain L1CR(-1) 1.000000 1.000000 1.000000 1.000000 L1NFL(-1) -0.880867 -15.45274 -0.515191 -1.925565 [-2.77320] [-2.92785] [-9.83420] [-8.15636] C -0.155192 2.935343 -0.569312 0.247744
  24. 24. 24 Adjustment parameters of Error Correction Term (ECT) Greece Italy Portugal Spain D(L1CR) D(L1NFL) D(L1CR) D(L1NFL) D(L1CR) D(L1NFL) D(L1CR) D(L1NFL) Full -0.163 0.121 -0.120 -0.025 -0.005 0.033 -0.084 0.0356 [-3.765] [1.316] [-3.993] [-0.289] [-0.586] [ 2.872] [-3.167] [ 0.508] Pre’08 -0.708 0.0436 -0.0807 -0.079 -0.146 -0.021 -0.387 0.206 [-5.156] [0.680] [-3.456] [-0.748] [-2.347] [-0.232] [-2.874] [ 0.491] Post’08 -0.203 0.588 -0.0266 0.0769 -1.647 -2.660 -0.024 1.366 [-1.960] [2.562] [-1.619] [ 2.481] [-1.822] [-2.625] [-0.054] [ 1.352] Note: t-statistics are given in square brackets. Significant cases at the 10% are given in bold.
  25. 25. 25
  26. 26. 26
  27. 27. 27
  28. 28. 28
  29. 29. Mini conclusions • Set up the analysis of capital flows and credit expansion • Theoretical reasons to analyse cr and nfl together • Descriptive analysis suggest correlation • Cointegration analysis shows clear causation, in most cases from capital inflows to credit expansion. Spain is different! (as usual ) • Clear changes in the behaviour of the relationship after 2008. 29
  30. 30. Comments?? Tänan väga 30

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