Abstract
Important issues of the Netherlands are discussed. Openness to trade has benefited the Netherlands before the crisis and has supported the recent recovery process. However, both financial openness and trade linkages have also been a transmission channel for the financial crisis. Synchronized fiscal tightening across Europe has important spillover effects for GDP growth. The improvement on the supply side of credit has contributed to a normalization of the credit market. However, the recent increase in the financial stress index indicates that the situation is still fragile.
Analytical Note 3: Macro-Financial Linkages1
1. The Dutch financial sector has been hit hard by the financial crisis, while the impact on the broader economy has also been pronounced but less severe. The recent developments in the indicators point toward a gradual improvement of the financial sector situation, but downside risks remain elevated.
Financial Stress Index (FSI)
Citation: IMF Staff Country Reports 2011, 143; 10.5089/9781455286645.002.A003
Source: IMF staff calculationsA. Financial Stress Indicator
2. The financial system has suffered major distress in the crisis and uncertainty remains high. To measure aggregate vulnerabilities in the financial system, we construct a financial stress index (FSI) based on variables related to the banking sector, securities markets and foreign exchange market.2 The evolution of the FSI indicates that the financial crisis has had a higher impact on the financial system in the Netherlands than on the average advanced economy or European country. After peaking during the crisis by end-2008, the index dropped rather rapidly to a temporary low by end-2009, but edged up again in mid-2010 due to increased volatility in the stock market and an increase in the stress in the banking sector. This indicates that uncertainty remains high and the recovery fragile.
B. Financial Spillovers on the Real Sector
3. Spillovers from the financial conditions remain a source of concern. Financial variables have affected the broader economy via multiple channels. Falling housing prices worsened the balance sheet position of households and are a potential factor limiting consumption growth. While credit demand has declined, stress in the banking sector and falling profitability of banks have added to the reduced credit growth via tighter conditions for loans. To analyze these channels in more detail and quantify the effects, we make use of three econometric approaches. First, we construct an index which allows us to evaluate the impact of the change in financial conditions on GDP. Second, we analyze the existence of a potential disequilibrium in the credit market. And, finally, we assess to which extent the output growth is affected by conditions in the credit market.
Financial Conditions and their Effect on Output
4. We use a VAR analysis to decompose the contribution of various financial indicators to economic activity. The overall financial condition index (FCI) is the sum of the cumulative impulse responses of real GDP to each of the financial variables. The latter variables include the house price index, the short term interest rate (AIBOR), the stock price index, the banking sector risk (measured by the beta estimated in a CAPM), and the real effective exchange rate. The value of the overall FCI reflects the overall contribution of financial conditions to GDP. Additionally, the impulse responses are standardized such that a change in the index by one unit can be interpreted as an (annualized) change in GDP growth by 1 percentage point.
Financial Conditions Index (FCI)
(percentage points of y/y real GDP growth)
Citation: IMF Staff Country Reports 2011, 143; 10.5089/9781455286645.002.A003
Source: IMF staff calculations.5. The evolution of the FCI implies a strong negative impact of financial conditions on GDP in 2009 and 2010. The FCI’s deteriorating trend since 2007Q4 until 2009Q4 suggests a significant cumulative reduction in GDP over the two years due to the deterioration in financial conditions. At the end of 2009 the index stood at -1.6 down from 1.6 in 2007Q4. While the downward trend stopped in 2010, the recovery is moderate and the negative overall contribution of the financial conditions to output is estimated to persist throughout 2010. For the first time in the observed sample range, all financial variables exert a negative impact on GDP. This and the absence of a fast improvement in asset markets, the interbank market and the banking sector indicate that a return to a positive contribution of financial conditions to GDP growth can only be slow.
6. The main contribution to negative growth in 2009 has come from falling stock market prices which have not recovered fully yet. The deterioration of equity prices and the temporary drying up of short term funding in the interbank market, have fuelled the stress in the banking sector via lower asset values and increased costs of refinancing.3 The estimated contribution of house price developments to GDP is negative since end 2009, but remains very low in absolute terms. However, a further deterioration in the housing market or a double dip in the stock market could constitute important sources of downside risk as the continued low levels of interest rates already constrain the profitability of the banking sector.
Credit Market Imbalances
7. Adverse financial conditions can feed into a mismatch of demand and supply in the credit market. However, the policy implications are very different depending on whether the mismatch is driven by the supply side (credit crunch) or the demand side (credit contraction) of credit. In the case of a credit crunch banks are constrained in their capacity to provide credit either because of liquidity problems or deleveraging. Thus, there is a case for policy to focus on restoring stability in the financial sector, possibly through direct support to financial institutions. In the event of a credit contraction, households and firms demand for credit is weak due to the economic outlook. In this case, policy should focus on fostering household and firm demand by improving the economic conditions for households and firms.
8. We estimate a system of equations for the demand for and the supply of credit to the private sector for the period from 1990Q1 to 2010Q2.4 The demand for credit is assumed to depend on the lending rate, inflation, economic activity, the stock price index, and the annual average of the producer confidence index (as a proxy for the economic outlook). The supply of credit is explained by total deposits (as a measure of available resources), the lending rate, the spread between lending and short term funding rate, inflation, economic activity, the beta of the banking sector to account for stress in the banking sector, the stock price index, and the annual volatility of the stock price index. The difference between the residuals of the supply and the residuals of the demand equation can be interpreted as disequilibrium in the credit market. An excess demand which coincides with a flat or falling volume of credit indicates the presence of a credit crunch.
9. The analysis suggests that the excess demand in 2008–09 has come to an end in 2010.5 The financial crisis was preceded in the Netherlands by an excess supply of credit for a prolonged period. This trend started to reverse in mid 2007 and quickly turned into an excess demand of close to 6 percent in 2009Q2. The excess demand (“credit crunch”) was driven by a faster decline in credit supply than in demand for credit, reflecting the adverse conditions in the financial sector and the associated deleveraging of several major banks. While credit demand remained subdued throughout last year, credit supply recovered on the back of improved access to capital and a moderation of the stress in the banking sector.
Netherlands: Excess Supply of / Demand for Credit
Citation: IMF Staff Country Reports 2011, 143; 10.5089/9781455286645.002.A003
Source: IMF staff estimates.10. While estimation results should be interpreted with caution, survey data on bank lending standards tends to confirm the conclusion. Lending conditions have been tightening for households as well as non financial corporations. The worsening coincides to a large extent with the period in which the estimation detects an excess demand for credit, while the neutral or lower credit standards coincide with a situation of excess supply. Tighter credit conditions were, however, mitigated to some extent by an increase in financing via bond markets for (large) non financial corporations. Surveys also indicate that larger corporations in particular have had fewer problems in obtaining credit. The general high level of profits preceding the crisis has provided firms with buffers which allowed absorbing tighter credit conditions without severe consequences (Taskforce Kredietverlening 2010). Additionally, the authorities estimate that extraordinary measures provided liquidity to firms of more than 4 billion euro, in 2009 and 2010, and additional 2.1 billion in 2011. This support, which is not reflected in the regression framework, could lower the estimated excess demand by 0.6–0.9 percentage points.
Bank Lending Standards Developments
Net percent of Dutch banks tightening credit standards compared to the previous quarter
Citation: IMF Staff Country Reports 2011, 143; 10.5089/9781455286645.002.A003
Source: CBSCredit Market Conditions and Growth
11. A higher sensitivity of output to credit growth indicates that disruptions in the credit market can be an important source of risk for growth. Thus, it is important to assess the strength of the relationship between output and credit growth for the Netherlands. We estimate several VAR models to capture the transmission of credit growth shocks to economic activity. The results are then used to compute short and medium run responses and quantify the contribution of the credit market developments to output fluctuations.
12. The VAR analysis points to a robust relationship between credit and output growth. We use quarterly data for the period from 1990Q4 to 2010Q2 to estimate three VAR models. The basic model (1) includes GDP and credit growth. The framework is extended in model (2) to include additionally consumption growth as a relevant transmission channel of credit on GDP growth. Finally model (3) controls for potential external developments by adding export growth. We find credit growth to be a significant explanatory variable in all of the estimation models (Table 3-1).
Impact of Credit Growth on Economic Activity
Impact of Credit Growth on Economic Activity
| Model 1 | Model 2 | Model 3 | ||||
|---|---|---|---|---|---|---|
| GDP | GDP | Consumption | GDP | Consumption | ||
| Impact of a Drop in Credit by 10% | ||||||
| -After 2 quarters | -1.03 | -0.93 | -0.77 | -0.80 | -0.88 | |
| -After 1 year | -2.29 | -2.21 | -1.64 | -2.06 | -1.68 | |
| -After 2 years | -3.08 | -2.72 | -2.09 | -2.39 | -2.16 | |
| Contribution to Variance (in % of total variance) | ||||||
| -After 2 quarters | 7.56 | 6.34 | 6.68 | 4.79 | 8.42 | |
| -After 1 year | 11.91 | 11.02 | 11.76 | 9.10 | 13.36 | |
| -After 2 years | 12.81 | 11.32 | 12.31 | 9.24 | 14.05 | |
| Reduced form Coefficient Estimates | ||||||
| Credit (t-1) | 0.10 | 0.09 | 0.08 | 0.08 | 0.09 | |
| (2.19) | (2.03) | (1.92) | (1.73) | (2.14) | ||
| Credit (t-2) | 0.04 | 0.05 | 0.07 | 0.03 | 0.08 | |
| (0.78) | (0.98) | (1.80) | (0.57) | (2.01) | ||
| GDP (t-1) | 0.36 | 0.40 | 0.15 | 0.31 | 0.21 | |
| (2.97) | (3.04) | (1.34) | (2.20) | (1.72) | ||
| GDP (t-2) | 0.01 | 0.11 | 0.04 | 0.05 | 0.08 | |
| (0.12) | (0.94) | (0.39) | (0.38) | (0.75) | ||
| Consumption (t-1) | 0.05 | -0.18 | 0.04 | -0.20 | ||
| (0.33) | (1.41) | (0.25) | (1.49) | |||
| Consumption (t-2) | -0.36 | -0.08 | -0.31 | -0.08 | ||
| (2.39) | (0.65) | (.155) | (.137) | |||
| Foreign demand (t-1) | 0.07 | -0.02 | ||||
| (1.65) | (0.64) | |||||
| Foreign demand (t-2) | 0.03 | -0.04 | ||||
| (0.73) | (1.15) | |||||
| Number of observation | 76 | 76 | 76 | 76 | 76 | |
| Adj. R-squared | 0.26 | 0.30 | 0.10 | 0.32 | 0.10 | |
Impact of Credit Growth on Economic Activity
| Model 1 | Model 2 | Model 3 | ||||
|---|---|---|---|---|---|---|
| GDP | GDP | Consumption | GDP | Consumption | ||
| Impact of a Drop in Credit by 10% | ||||||
| -After 2 quarters | -1.03 | -0.93 | -0.77 | -0.80 | -0.88 | |
| -After 1 year | -2.29 | -2.21 | -1.64 | -2.06 | -1.68 | |
| -After 2 years | -3.08 | -2.72 | -2.09 | -2.39 | -2.16 | |
| Contribution to Variance (in % of total variance) | ||||||
| -After 2 quarters | 7.56 | 6.34 | 6.68 | 4.79 | 8.42 | |
| -After 1 year | 11.91 | 11.02 | 11.76 | 9.10 | 13.36 | |
| -After 2 years | 12.81 | 11.32 | 12.31 | 9.24 | 14.05 | |
| Reduced form Coefficient Estimates | ||||||
| Credit (t-1) | 0.10 | 0.09 | 0.08 | 0.08 | 0.09 | |
| (2.19) | (2.03) | (1.92) | (1.73) | (2.14) | ||
| Credit (t-2) | 0.04 | 0.05 | 0.07 | 0.03 | 0.08 | |
| (0.78) | (0.98) | (1.80) | (0.57) | (2.01) | ||
| GDP (t-1) | 0.36 | 0.40 | 0.15 | 0.31 | 0.21 | |
| (2.97) | (3.04) | (1.34) | (2.20) | (1.72) | ||
| GDP (t-2) | 0.01 | 0.11 | 0.04 | 0.05 | 0.08 | |
| (0.12) | (0.94) | (0.39) | (0.38) | (0.75) | ||
| Consumption (t-1) | 0.05 | -0.18 | 0.04 | -0.20 | ||
| (0.33) | (1.41) | (0.25) | (1.49) | |||
| Consumption (t-2) | -0.36 | -0.08 | -0.31 | -0.08 | ||
| (2.39) | (0.65) | (.155) | (.137) | |||
| Foreign demand (t-1) | 0.07 | -0.02 | ||||
| (1.65) | (0.64) | |||||
| Foreign demand (t-2) | 0.03 | -0.04 | ||||
| (0.73) | (1.15) | |||||
| Number of observation | 76 | 76 | 76 | 76 | 76 | |
| Adj. R-squared | 0.26 | 0.30 | 0.10 | 0.32 | 0.10 | |
13. A potential contraction in credit growth could affect output growth notably.6 Shocks to credit growth account for 9–12 percent of the variation in output growth at the one year horizon. A reduction in credit growth reduces private consumption which in turn decelerates output growth. According to the estimates, a 10 percent negative shock to credit growth reduces average (annual) consumption growth by 1.7 percent and average (annual) output growth by 2.1 percent.
C. Conclusion
14. The financial sector has been an important contributing factor to the negative GDP growth experienced recently. The Dutch financial sector has been affected particularly strongly by the financial crisis. Besides the sheer size of the banking sector, this was also a result of important macro-financial linkages in the Netherlands. These linkages are apparent in the key role that both the financial system and the credit market play in the transmission of shocks to economic activity. The deterioration of financial conditions during the crisis translated into a credit crunch and a significant reduction in growth.
15. While there are signs of improvement, the recovery appears fragile. The situation in the financial sector has had a direct impact on the supply of credit during the crisis and on output growth. The improvement on the supply side of credit has contributed to a normalization of the credit market. Conditional on a continuation of that trend, exit measures should be put in place, and measures to revive the situation of firms and households should take center stage. However, the recent increase in the financial stress index indicates that the situation is still fragile and a relapse, while unlikely, cannot be ruled out entirely.
References
Balakrishnan, Ravi, Selim Elekdag, Stephan Danninger, and Irina Tytell, 2009, “The Transmission of Financial Stress from Advanced to Emerging Economies,” IMF Working Paper 09/133 (Washington: International Monetary Fund).
Cardarelli, Roberto, Selim Elekdag, and Subir Lall, 2009, “Financial Stress, Downturns, and Recoveries,” IMF Working Paper 09/100 (Washington: International Monetary Fund).
Roca, Paulo, 2010, “Macro-Financial Linkages,” in Finland: 2010 Article IV Consultation IMF Country Report No. 10/273 (Washington: International Monetary Fund).
Ministerie van Economische Zaken, Landbouw en Innovatie, 2010, “Eindverslag van de Taskforce Kredietverlening” (December).
Pazarbasiouglu, Ceyla, 1997, “A Credit Crunch? Finland in the Aftermath of the Banking Crisis,” IMF Staff Papers No. 44, pp. 315–27 (Washington: International Monetary Fund).
Prepared by Sebastian Weber.
The financial stress index (FSI) is a composite of the spread between commercial papers and sovereign bonds, the beta of the banking sector (from a CAPM), the term structure of interest rates, and volatilities in stock returns and the exchange rate. Large values imply higher distress. A value of zero indicates neutral financial conditions. See Cardarelli et el. (2009) and Balakrishnan et al. (2009)
The Choleski decomposition is obtained by ordering output first followed by the price level, the banking sector risk, the interbank rate, the real exchange rate, the stock market index and the house price index. The conclusions are robust to changes in the ordering.
The analysis is based on Pazarbasioglu (1997) and has and recently been applied again to Finland by Roca (2010). The credit data refers to the loans to the private sector. Using the loan data adjusted for securitization, implies a somewhat weaker excess demand, but does not alter the general conclusion.
The exact timing of the start and end of the credit crunch varies slightly with the choice of the determinants of demand and supply. However, the magnitude of the credit crunch and the general evolution of the mismatch of demand for and supply of credit remain robust to various changes in the choice of the explanatory variables.
While the exact magnitudes vary slightly, results are robust to a change in the ordering of the variables. Numbers reflect a lower bound estimate since credit growth is generally ordered last while other variables are allowed to impact GDP growth contemporaneously in the case of model (2) and model (3).
