Economic Spillovers from the Euro Area to the CESEE Region via the Financial Channel: A GVAR Approach

In this paper we examine the spillovers of a shock to real output in the euro area to Central, Eastern and Southeastern Europe (CESEE) and its subregions Central Europe, Southeastern Europe, Russia, and the other members of the Commonwealth of Independent States (CIS). To this effect, we apply a global vector autoregressive (GVAR) model and go beyond existing work by examining the relative importance of the financial channel compared with the trade channel. Moreover, we assume that shocks spill over from the euro area to the CESEE region via the financial channel whereas financial spillovers within CESEE are negligible (except for spillovers between Russia and the other CESEE countries, which we do capture). Our results are as follows: We find spillovers transmitted via the trade channel to be larger than spillovers via the financial channel for Southeastern Europe, but smaller for Russia and the other CIS countries. For Central Europe, the two channels have a broadly similar impact. When we assess the relative importance of the two channels based on how well they explain historical movements in the data we see that spillovers via the two channels have indeed been of equal importance for Central Europe. However, the financial channel has traditionally dominated the trade channel in Southeastern Europe, whereas the trade channel has traditionally played a stronger role for the CIS region. Overall spillovers reflecting both transmission channels are comparatively more moderate for Central Europe and Russia, while they are a bit larger for Southeastern Europe and considerably higher for the CIS region excluding Russia: The long-run effect of a +1% euro area output shock ranges from 0.3% in Central Europe and Russia to 0.7% in the other CIS countries.