Credit Spreads and the Links between the Financial and Real Sectors in a Small Open Economy: The Case of the Czech Republic

Various approaches have been employed to explore the possibility of non-linear feedback between the real and financial sectors. The present study focuses on the impact of real shocks on selected financial sector indicators and the responses of the real economy to impulses emanating from the financial sector. We estimate a threshold Bayesian VAR with block restrictions and the credit spread as a threshold variable using the example of the Czech Republic. We find that while there is no evidence of asymmetric effects across positive and negative shocks, the responses of the financial sector to real shocks tend to differ below and above the credit spread threshold. Responses in the opposite direction (i.e. from the financial sector to the real economy) are pro-cyclical and similar irrespective of regime. A positive shock to credit and a negative shock to the NPL (nonperforming loans) increase industrial production over the entire time horizon. The direct impact of foreign factors on lending seems to be rather limited.