Financial Conditions Index and Identification of Credit Supply Shocks for the Euro Area

type="main" xml:lang="en"> <title type="main">Abstract</title> <p>The international financial crisis and the euro-area sovereign debt crisis brought to the fore the importance of financial conditions to the macro-economy. The complexity of the financial sector means that a wide range of financial variables is needed to fully characterize its functioning in real time. In this paper we construct a financial conditions index (FCI) for the euro area following the studies by Hatzius et al. and Brave and Butters. Our FCI successfully tracks both worldwide and euro-area-specific financial events. We then incorporate the FCI into a VAR model comprising output, inflation, the monetary policy rate, bank loans and bank lending spreads to identify credit supply shocks with sign restrictions. These shocks are estimated to have caused around one-fifth of the decline in euro-area manufacturing production at the trough of the financial crisis and a rise in bank lending spreads of around 30 basis points. </section>