Financial instability in the context of endogenous money

The European Union is more reliant on bank credits and bank intermediation of savings, than the United States and rest of the world. Consequently, banking system stability plays a crucial role for sustained recovery in Europe after the financial crises. The risk of financial instability is driven by the economic and credit cycles over time, as well as by the degree of interconnectedness of financial institutions and markets. We focus on the banking systems in the CEECs which is characterized by a significant presence of foreign banks.

In the paper we applied conventional VECM with known cointegration vector and a linear trend in the cointegration relation, where the long-term connection of money and economic (investment) activity is developed in the quantity theory of money. The long term equilibrium of velocity is identified by filtering techniques. We found different speed of adjustment based on liquidity indicators of the selected commercial banks. The data sets were provided by IMF financial statistics and Bankscope database.

Our contribution is identification of heterogeneous liquidity among the selected countries. The results are discussed in the context of the Minsky´s financial instability hypothesis.