Financial stress and economic activity in Germany

The financial crisis and the European sovereign debt crisis have shown that financial stress may be an important driver for economic activity. In this paper, I derive a financial stress index for Germany, using a dynamic approximate factor model that summarises a stress component of various financial variables. Subsequently, I analyse the effects of financial stress on economic activity in a threshold vector autoregressive model. I find that if the index exceeds a certain threshold, an increase in financial stress causes economic activity to decelerate significantly, whereas if it is below this threshold, economic activity remains nearly unaffected.