The predictive power of financial variables and the asymmetric impact of monetary policy in the Euro Area

This thesis contributes to several debates on the role of financial conditions in affecting monetary policy transmission and in predicting economic activity by providing new empirical evidence within linear and nonlinear framework. The focus of the first chapter is to provide a comparison of the theoretical and empirical approaches that have been employed to investigate the nature of the nexus between financial and real economy. I concentrate more on the works that examine how financial imperfections are important in the monetary policy transmission mechanism and how financial information helps in forecasting the real economy. There is a large consensus that financial frictions lead to a rise in the persistence and the amplitude of monetary policy effects. Moreover, financialindicators have proved to be useful in predicting economic activity. The second chapter studies the interaction between financial frictions and economic activity by investigating to what extent the information provided by financial stress indicators is useful in forecasting euro area economic activity, especially rare macroeconomic outcomes such as the Great Recession. To this end, I estimate a set of linear and non-linear BVAR models andevaluate their relative performance from both a point- and density-forecast perspective. In a pseudo real-time out-of-sample forecasting exercise, I find that financial stress indicators wouldhave sent clear signals of significant downside risks for euro area economic activity well before the contraction of euro area GDP. Correspondingly, I find that their forecast performance, whenevaluated in terms of probability distribution results superior to that of standard models that omit the link between finance and the macroeconomics. The third chapter investigates the potential for the state-dependent nature of monetary policy transmission in the European union within a framework that involves financial frictions. Inorder to achieve this objective, I compare the different responses to a monetary policy shocks generated by a set of linear and nonlinear Bayesian VAR models. I find that financial conditions matter in the transmission of monetary policy and are crucial in determining a larger impact during periods of recession.