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A Financial Conditions Index for the United States

Author

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  • Kimberly Beaton
  • René Lalonde
  • Corinne Luu

Abstract

The financial crisis of 2007-09 has highlighted the importance of developments in financial conditions for real economic activity. The authors estimate the effect of current and past shocks to financial variables on U.S. GDP growth by constructing two growthbased financial conditions indexes (FCIs) that measure the contribution to quarterly (annualized) GDP growth from financial conditions. One FCI is constructed using a structural vector-error correction model and the other is constructed using a large-scale macroeconomic model. The authors' results suggest that financial factors subtracted around 5 percentage points from quarterly annualized real GDP growth in the United States in 2008Q4 and 2009Q1 and should subtract another 5 percentage points from growth in 2009Q2. Moreover, to assess the effect of financial shocks in terms of policy interest rate equivalent units, the authors convert the effect of financial developments on growth into the number of basis points by which the federal funds rate has been tightened. The authors show that the tightening of financial conditions since mid-2007 is equivalent to about 300 basis points of tightening in terms of the federal funds rate. Thus, the aggressive monetary easing undertaken by the Federal Reserve over the financial crisis has not been sufficient to offset the tightening of financial conditions. Finally, in a key contribution to the literature, the authors assess the relationship between financial shocks and real activity in the context of the zero lower bound. They find that the effect of the tightening of financial conditions on GDP growth in the current crisis may have been amplified by as much as 40 per cent due to the fact that policy interest rates reached the zero lower bound.

Suggested Citation

  • Kimberly Beaton & René Lalonde & Corinne Luu, 2009. "A Financial Conditions Index for the United States," Discussion Papers 09-11, Bank of Canada.
  • Handle: RePEc:bca:bocadp:09-11
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    File URL: http://www.bankofcanada.ca/en/res/dp/2009/dp09-11.pdf
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    References listed on IDEAS

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    1. Charles A. E. Goodhart & Boris Hofmann, 2001. "Asset prices, financial conditions and the transmission of monetary policy," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
    2. Mayes, David G. & Viren , Matti, 2002. "Financial Conditions Indexes," Economia Internazionale / International Economics, Camera di Commercio Industria Artigianato Agricoltura di Genova, vol. 55(4), pages 521-550.
    3. Stéphanie Guichard & David Turner, 2008. "Quantifying the Effect of Financial Conditions on US Activity," OECD Economics Department Working Papers 635, OECD Publishing.
    4. Peter A. Tinsley, 1993. "Fitting both data and theories: polynomial adjustment costs and error- correction decision rules," Finance and Economics Discussion Series 93-21, Board of Governors of the Federal Reserve System (U.S.).
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    Citations

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    Cited by:

    1. Chang, Chia-Lin, 2015. "Modelling a latent daily Tourism Financial Conditions Index," International Review of Economics & Finance, Elsevier, vol. 40(C), pages 113-126.
    2. repec:hal:journl:halshs-01110688 is not listed on IDEAS
    3. de Bondt, Gabe & Maddaloni, Angela & Peydró, José-Luis & Scopel, Silvia, 2010. "The euro area Bank Lending Survey matters: empirical evidence for credit and output growth," Working Paper Series 1160, European Central Bank.
    4. Chang, C-L. & Hsu, H-K. & McAleer, M.J., 2014. "A Tourism Financial Conditions Index," Econometric Institute Research Papers EI2014-11, Erasmus University Rotterdam, Erasmus School of Economics (ESE), Econometric Institute.
    5. Osborne-Kinch, Jenny & Holton, Sarah, 2010. "A Discussion of the Monetary Condition Index," Quarterly Bulletin Articles, Central Bank of Ireland, pages 68-80, January.
    6. Koop, Gary & Korobilis, Dimitris, 2014. "A new index of financial conditions," European Economic Review, Elsevier, vol. 71(C), pages 101-116.
    7. Rémy Charleroy & Michael A. Stemmer, 2014. "An Emerging Market Financial Conditions Index: A VAR Approach," Université Paris1 Panthéon-Sorbonne (Post-Print and Working Papers) halshs-01110688, HAL.

    More about this item

    Keywords

    Business fluctuations and cycles; Monetary conditions index; Monetary and financial indicators; Recent economic and financial developments;

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E47 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Forecasting and Simulation: Models and Applications
    • E51 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Money Supply; Credit; Money Multipliers

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