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Diagnosing the Financial System: Financial Conditions and Financial Stress

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  • Scott Brave

    (Stanford University)

  • R. Andrew Butters

    (Stanford University)

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    Abstract

    We approach the task of monitoring financial stability within a framework that balances the costs and benefits of identifying future crisis-like conditions based on past U.S. financial crises. Our results indicate that the National Financial Conditions Index (NFCI) produced by the Federal Reserve Bank of Chicago is a highly predictive and robust indicator of financial stress at leading horizons of up to one year, with measures of leverage playing a crucial role in signaling financial imbalances. At longer forecast horizons, we propose an alternative sub-index of the NFCI that captures the relationship between non-financial leverage, financial stress, and economic activity.

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    Bibliographic Info

    Article provided by International Journal of Central Banking in its journal International Journal of Central Banking.

    Volume (Year): 8 (2012)
    Issue (Month): 2 (June)
    Pages: 191-239

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    Handle: RePEc:ijc:ijcjou:y:2012:q:2:a:6

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    1. Catherine Doz & Domenico Giannone & Lucrezia Reichlin, 2012. "A Quasi–Maximum Likelihood Approach for Large, Approximate Dynamic Factor Models," The Review of Economics and Statistics, MIT Press, vol. 94(4), pages 1014-1024, November.
    2. Mathias Drehmann & Claudio Borio & Leonardo Gambacorta & Gabriel Jiminez & Carlos Trucharte, 2010. "Countercyclical capital buffers: exploring options," BIS Working Papers 317, Bank for International Settlements.
    3. Fabian Valencia & Luc Laeven, 2008. "Systemic Banking Crises," IMF Working Papers 08/224, International Monetary Fund.
    4. Troy Matheson, 2011. "Financial Conditions Indexes for the United States and Euro Area," IMF Working Papers 11/93, International Monetary Fund.
    5. Stock J.H. & Watson M.W., 2002. "Forecasting Using Principal Components From a Large Number of Predictors," Journal of the American Statistical Association, American Statistical Association, vol. 97, pages 1167-1179, December.
    6. Illing, Mark & Liu, Ying, 2006. "Measuring financial stress in a developed country: An application to Canada," Journal of Financial Stability, Elsevier, vol. 2(3), pages 243-265, October.
    7. Durbin, James & Koopman, Siem Jan, 2001. "Time Series Analysis by State Space Methods," OUP Catalogue, Oxford University Press, number 9780198523543.
    8. Stacey L. Schreft, 1990. "Credit controls: 1980," Economic Review, Federal Reserve Bank of Richmond, issue Nov, pages 25-55.
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    Cited by:
    1. Alejandro Justiniano, 2012. "Comment on "Structural and Cyclical Forces in the Labor Market during the Great Recession: Cross-Country Evidence"," NBER Chapters, in: NBER International Seminar on Macroeconomics 2012, pages 415-424 National Bureau of Economic Research, Inc.
    2. Fabian Fink & Yves S. Schüler, 2013. "The Transmission of US Financial Stress: Evidence for Emerging Market Economies," Working Paper Series of the Department of Economics, University of Konstanz 2013-01, Department of Economics, University of Konstanz.
    3. Piergiorgio Alessandri & Haroon Mumtaz, 2013. "Financial conditions and density forecasts for US Output and inflation," Joint Research Papers 4, Centre for Central Banking Studies, Bank of England.
    4. Sofiane Aboura & Björn van Roye, 2013. "Financial stress and economic dynamics: an application to France," Kiel Working Papers 1834, Kiel Institute for the World Economy.
    5. Schüler, Yves S. & Fink, Fabian, 2013. "The Transmission of US Financial Stress: Evidence for Emerging Market Economies," Annual Conference 2013 (Duesseldorf): Competition Policy and Regulation in a Global Economic Order 79692, Verein für Socialpolitik / German Economic Association.
    6. A. Hakan Kara & Pinar Ozlu & Deren Unalmis, 2012. "Financial Conditions Indices for the Turkish Economy," CBT Research Notes in Economics 1231, Research and Monetary Policy Department, Central Bank of the Republic of Turkey.
    7. Eleni Angelopoulou & Hiona Balfoussia & Heather D. Gibson, 2012. "Building a financial conditions index for the euro area and selected euro area countries: what does it tell us about the crisis?," Working Papers 147, Bank of Greece.

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