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Evaluating early warning indicators of banking crises: Satisfying policy requirements

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  • Drehmann, Mathias
  • Juselius, Mikael

Abstract

Ideally, early warning indicators (EWI) of banking crises should be evaluated on the basis of their performance relative to the macroprudential policy maker’s decision problem. We translate several practical aspects of this problem — such as difficulties in assessing the costs and benefits of various policy measures, as well as requirements for the timing and stability of EWIs — into statistical evaluation criteria. Applying the criteria to a set of potential EWIs, we find that the credit-to-GDP gap and a new indicator, the debt service ratio (DSR), consistently outperform other measures. The credit-to-GDP gap is the best indicator at longer horizons, whereas the DSR dominates at shorter horizons.

Suggested Citation

  • Drehmann, Mathias & Juselius, Mikael, 2014. "Evaluating early warning indicators of banking crises: Satisfying policy requirements," International Journal of Forecasting, Elsevier, vol. 30(3), pages 759-780.
    • Handle: RePEc:eee:intfor:v:30:y:2014:i:3:p:759-780
    DOI: 10.1016/j.ijforecast.2013.10.002
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