Macro-Financial Linkages : The Role of Liquidity Dependence

We estimate a panel Bayesian vector autoregression model for a cross-section of seven advanced European economies and produce out-of-sample forecasts of GDP conditionally on observed developments of interest rates and credit. We show that by using a smooth transition version of the model and allowing the parameters to vary across economies conditionally on their liquidity dependence, it is possible to improve the accuracy of the forecasts. We conclude that the degree of liquidity dependence is likely to be among the important predictors of heterogeneity in macro-financial linkages across countries