Macro-financial linkages: The role of the institutional framework

Abstract

In this paper, we assess the quantitative impact of various financial shocks on the real activity and explicitly address the issue of heterogeneity in the macro-financial linkages. For that purpose, we use VAR models as well as the local projection method for 18 OECD countries based on quarterly data between 1995 and 2014. We take into account three main dimensions of the institutional framework likely to explain the observed cross-country heterogeneity in the propagation of financial shocks: the product market regulation, the employment protection, and the financial structure. Our main findings indicate that financial shocks have a stronger impact in countries characterized by a higher competition-friendly regulatory stance, a stronger employment protection, and a more market-oriented financial structure. We also show that the varieties of capitalism, described by the particular mix of different institutional arrangements, do not play a significant role in shaping the macro-financial linkages. This result suggests that, although considered individually, goods, labor, and financial markets regulations are robustly linked to macroeconomic fluctuations, there is no prima facie evidence for superior performance of any given mix of institutional arrangements observed in OECD countries.