Financial stability and economic performance in Europe

Abstract : This paper aims at establishing the link between economic performance and financial stability in the European Union. We use the seminal framework of Beck and Levine (2004) – both in terms of variables and econometric method – to estimate this causal relationship, independently from but controlling for the level of financial depth. Using a panel GMM with instrumental variables, our contribution involves testing how different measures of financial instability (an institutional index, microeconomic indicators, and our own statistical index derived from a principal component analysis) affect economic performance (or components of aggregate dynamics like consumption, investment and disposable income). We find that financial instability has a negative effect on economic growth.