Financial intermediaries' instability and euro area macroeconomic dynamics

Fitting a Markov-switching structural vector autoregression to euro area data, we show that, after taking into account heteroskedasticity, the differences in the behavior of the economy between tranquil and financial distress periods (e.g., Great Recession and sovereign debt crisis) reflect variations in the transmission mechanism. When and only when a period of financial distress occurs, disruptions in financial intermediation trigger adverse effects for the real economy and turn out to be the primary source of business cycle fluctuations. Finally, we provide strong evidence that ECB interventions in the financial sector had beneficial effects on the real economy during the sovereign debt crisis. (C) 2017 Elsevier B.V. All rights reserved.