Eesti Pank seminar, 30th June 2014

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 Preliminary work, please do not
quote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. 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. 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
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
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. 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. Structure of the presentation
• Introduction/motivation
• Brief literature review
• Data and graphs
• Method and results
• Mini conclusions
• Comments, discussion, complaints 
7

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. 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. Introduction (cont’d)
Capital inflows Credit expansion
10

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. 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. 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. 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. 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. 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
.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
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. 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. 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
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
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
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
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

26. 26

27. 27

28. 28

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. Comments??
Tänan väga
30