A monthly financial conditions index for New Zealand

Financial conditions refer to the state of financial variables such as interest rates, share prices, house prices and exchange rates. If financial conditions in the economy are ‘loose’, they stimulate real economic activity, and if they are ‘tight’, economic activity is constrained. The implications of financial conditions for macroeconomic outcomes has motivated the development of financial conditions indices (FCIs) that summarise common movements in financial and macroeconomic data. In general, an FCI offers a gauge of how shifts in central bank policy and economic outlooks, including foreign financial condition shocks, are filtering out into the real world. A timely FCI would help the policy-maker assess, almost in real time, whether financial conditions in the economy are loose or tight. However, the development of a timely FCI is not a straightforward task because the data used to estimate it may be available at different frequencies – semi-annual or quarterly or weekly or daily intervals - and are also often incomplete. Financial data are available at ‘high frequencies’, that is, sometimes even at a daily or hourly frequency, but may be hampered by missing values. On the other hand, macroeconomic time series such as Gross Domestic Product, GDP, or household consumption are only available at quarterly frequencies. In this paper, Miguel Herculano constructs a monthly FCI for New Zealand, using novel estimation techniques that resolve problems posed by missing data, and also enable the use of data that are available at different time frequencies. Since the new FCI is timelier than other alternatives that are available only at a quarterly frequency, it makes it more appealing to policymakers. The new FCI summarises information from 73 relevant financial and macroeconomic variables that are available at either monthly or quarterly frequencies. Interest rate spreads and mortgage lending are found to be the most relevant contributors to the dynamics of the monthly FCI. Estimates suggest that changes in the FCI have exerted relatively stronger influences on the New Zealand business cycle in more recent years. The predictive content of the financial conditions index for forecasting GDP and unemployment is not explored in the current version of the paper and is left for future research. About the research programme The Reserve Bank carries out a wide range of research related to monetary policy. This research programme may or may not change our overall view of monetary policy- whether rates should be raised or cut and by how much. The Reserve Bank’s overarching aim is to promote the prosperity and well-being of all New Zealanders. With monetary policy, our core focus is to support full employment and low and stable inflation. Monetary policy remains an effective, but blunt, tool to achieve these goals