Macroeconomic responses to financial stress shocks: Evidence from the US and the Eurozone

Abstract

This paper investigates the macroeconomic effects of an unexpected financial stress shock in the United States and the Eurozone, focusing mainly on the effect on unemployment and the response of monetary policy. First, we estimate Impulse Response Functions (IRFs) based on a Structural Vector Autoregression (SVAR) model with short-run restrictions according to economic theory. Next, we perform panel data analysis shedding light on the factors that affect unemployment in the two regions. Our findings indicate a significant impact of financial stress shocks on the macroeconomic environment, but with different policy responses from the Federal Reserve (Fed) and the European Central Bank (ECB). The impact of higher financial stress on economic activity and employment is negative in both regions, but the duration of the impact on unemployment is shorter in the US, suggesting a quicker recovery in the US labor market compared to the Eurozone. The faster recovery of the US labor market is primarily due to the superior institutional and regulatory performance in the US. These findings provide policymakers with valuable lessons about the importance of continuous monitoring and quick action to mitigate the negative effects of financial instability on economic activity.