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A financial conditions index for Iceland

Author

Listed:
  • Eysteinn Einarsson
  • Stella Einarsdottir
  • Tomas Dan Halldorsson
  • Vedis Sigridur Ingvarsdottir

Abstract

In this paper we remedy the lack of formalized relations between financial health and economic activity via a Financial Conditions Index for Iceland (FCI). We use a broad spectrum of financial information including price, spread, volatility and quantity variables, for the period 2002-2023. Variable selection is in line with broad consensus in the relevant literature. In addition, we include variables that are shown to have prediction properties vis-à-vis growth of real GDP over the horizon of two and four quarters ahead. The FCI is constructed using principal component analysis and is normalized such that a positive value indicates that financial conditions are looser than the historical average, while a negative value suggest that financial conditions are tighter than the historical average. We show that fluctuations and extreme events in historical real economic activity is captured by the FCI, implying that it is potentially a leading indicator of GDP developments.

Suggested Citation

  • Eysteinn Einarsson & Stella Einarsdottir & Tomas Dan Halldorsson & Vedis Sigridur Ingvarsdottir, 2023. "A financial conditions index for Iceland," Economics wp93, Department of Economics, Central bank of Iceland.
    • Handle: RePEc:ice:wpaper:wp93
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    References listed on IDEAS

    as
    1. Ben S. Bernanke & Mark Gertler, 1999. "Monetary policy and asset price volatility," Economic Review, Federal Reserve Bank of Kansas City, vol. 84(Q IV), pages 17-51.
    2. Claudio Borio, 2014. "The financial cycle and macroeconomics: what have we learned and what are the policy implications?," Chapters, in: Ewald Nowotny & Doris Ritzberger-Grünwald & Peter Backé (ed.), Financial Cycles and the Real Economy, chapter 2, pages 10-35, Edward Elgar Publishing.
    3. Borio, Claudio, 2014. "The financial cycle and macroeconomics: What have we learnt?," Journal of Banking & Finance, Elsevier, vol. 45(C), pages 182-198.
    4. Ben S. Bernanke, 2018. "The Real Effects of Disrupted Credit: Evidence from the Global Financial Crisis," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 49(2 (Fall)), pages 251-342.
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    More about this item

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination

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