Macro-financial linkages: the role of liquidity dependence

BIS Working Papers  |  No 716  | 
27 April 2018



This paper tests whether the linkages between financial and macroeconomic variables are similar in the economies that have the same degree of liquidity dependence (i.e. the same share of industries that are sensitive to the availability of funding from external sources).


There is ample literature on the link between the macroeconomic developments in times of financial stress and the economies' industrial composition. We contribute to this strand of research in several ways. Firstly, we compile a dataset of industry-level liquidity dependence indicators that are directly measured and cover all economic activities (not just manufacturing). Secondly, we employ a more general (and arguably more practical) econometric approach that does not limit our study to an analysis of one-off events (e.g. financial crises or recessions).


We find that the differences in the linkage between financial and macroeconomic variables across seven European economies are associated with the degree of their liquidity dependence. In fact, by incorporating this feature into a formal econometric model it is possible to improve its forecasting accuracy (as compared with the performance of the linear country-specific models). We interpret this result as an indication of importance of an economy's liquidity dependence in the determination of linkages between real and financial variables.



We estimate a panel Bayesian vector autoregression model for a cross-section of seven advanced European economies and produce out-of-sample forecasts of GDP conditionally on observed developments of interest rates and credit. We show that, by using a smooth transition version of the model and allowing the parameters to vary across economies conditionally on their liquidity dependence (i.e. dependence on the availability of funding from external sources), it is possible to improve the accuracy of the forecasts. We conclude that the degree of liquidity dependence is likely to be among the important predictors of heterogeneity in macro-financial linkages across countries.

JEL classification: G2, O16, C32

Keywords: liquidity dependence, macro-financial linkages, Smooth Transition Bayesian VAR