Unveiling the Hidden Threat: Rolling Recessions and Their Impact on Our Financial Stability
In a world where economic shocks can hit like a wave, we often overlook the subtle yet powerful force of rolling recessions. These sector-specific downturns, like a slow-burning fire, can mask underlying vulnerabilities and complicate our understanding of risk. But here's where it gets controversial: could these rolling recessions be the catalyst for a systemic crisis?
Prepared by a team of experts, including Peter Bednarek, Sándor Gardó, Ana Goulão Diogo Bandeira, and Benjamin Klaus, this article delves into the intricate world of macro-financial risks. Published as part of the Financial Stability Review in November 2025, it sheds light on a critical issue that might just change the way we perceive economic downturns.
The Enigma of Rolling Recessions
Despite the significant macroeconomic challenges and corporate vulnerabilities in the euro area, traditional indicators like the non-performing loan (NPL) ratio have remained surprisingly stable. This disconnect, often attributed to fiscal support and inflation dynamics, might actually point to a structural shift in economic downturns. Unlike traditional, uniform recessions, rolling recessions are sectoral downturns that propagate sequentially, exacerbating weaknesses over time.
Firm-Level Frictions and Economic Shocks
Firms, due to fixed costs, irreversibility, and uncertainty, adjust their capital and output only in response to substantial deviations. This rigidity means they delay action until shocks become significant, amplifying microeconomic frictions. Moreover, the nature of economic shocks is evolving. Sector-specific shocks like climate change and technological advances are becoming more prominent, while traditional shocks like oil price fluctuations are less impactful due to shifts in energy use and globalisation.
The Staggered Vulnerabilities
Rolling recessions create pockets of vulnerability in specific sectors. Evidence suggests that these vulnerabilities can materialise without affecting the broader economy until they reach a critical mass. Sectors like agriculture, construction, and energy-sensitive industries face margin pressures and financing constraints due to external factors. Some sectors, like construction and agriculture, are inherently more vulnerable to weather conditions and climate change, while others, like industry, are more sensitive to financing and energy price dynamics.
When Waves Align: Systemic Risks
While rolling recessions are typically asynchronous, they can converge and become systemic. Evidence from the euro area shows a spike in sectoral growth correlations during major crises. Synchronisation can be triggered by common shocks, leading to contagion across sectors. As sectoral downturns align, banks face deteriorating asset quality and rising capital needs, especially if their exposures are concentrated in specific sectors.
Credit Losses and Systemic Vulnerabilities
Aligned sector-specific downturns could result in correlated credit losses across the banking sector. High NPL correlations across key sectors indicate potential spillover risks. Despite the current disconnect between macro-financial uncertainty and credit risk metrics, the number of sectors with rising NPL ratios has increased since 2022. This could lead to simultaneous losses across loan portfolios, turning localised sectoral downturns into systemic credit events.
Addressing the Risks
To mitigate the risks stemming from rolling recessions, risk surveillance frameworks and policy tools must capture sectoral patterns of vulnerability. This involves moving beyond aggregate indicators and analysing data by sector, region, and borrower type, while enhancing the availability and quality of granular data.
And This Is the Part Most People Miss...
The concept of rolling recessions is not new, but its potential impact on systemic risks is often overlooked. As we navigate an increasingly complex economic landscape, understanding these rolling recessions and their ability to create hidden vulnerabilities is crucial. It's time we pay attention to the subtle shifts and patterns that could shape our financial future.
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