Unbroken in 40 years it would seem, but there’s been a notable lack of volatility over the past half-decade or so…
The chart is not completely random. It comes from a paper looking at whether the array of leading indicators monitored by market professionals can actually be boiled down to one super-indicator.
Financial Conditions Indexes: A Fresh Look after the Financial Crisis
Jan Hatzius, Peter Hooper, Frederic Mishkin, Kermit L. Schoenholtz and Mark W. Watson
Hatzius, of course, is from Goldman, while Hooper is a Deutsche man and Mishkin is a former Fed governor.
This report explores the link between financial conditions and economic activity. We first review existing measures, including both single indicators and composite financial conditions indexes (FCIs). We then build a new FCI that features three key innovations. First, besides interest rates and asset prices, it includes a broad range of quantitative and survey-based indicators. Second, our use of unbalanced panel estimation techniques results in a longer time series (back to 1970) than available for other indexes. Third, we control for past GDP growth and inflation and thus focus on the predictive power of financial conditions for future economic activity. During most of the past two decades for which comparisons are possible, including the last five years, our FCI shows a tighter link with future economic activity than existing indexes, although some of this undoubtedly reflects the fact that we selected the variables partly based on our observation of the recent financial crisis. As of the end of 2009, our FCI showed financial conditions at somewhat worse-than-normal levels. The main reason is that quantitative credit measures (e.g. asset-backed securities issuance) remain very weak, especially once we control for past economic growth. Thus, our analysis is consistent with an ongoing modest drag from financial conditions on economic growth in 2010.
The paper was actually presented at the annual Monetary Policy Forum held at the end of last month at the Chicago Booth School of Business.
But can you really have one single index that weighs all the other indicators and tells you, barometer-style, what the financial weather is going to be?
Discussing the paper at the Chicago event, New York Fed president William Dudley did not sound convinced.
As the financial system changes over time, both in terms of structure and in terms of financial products, the financial variables that we might determine to be important are also changing…
Variables that would work best 10 years ago as forecasting tools may no longer be very useful. As the structure of the financial system changes, the identity of variables that capture financial conditions naturally changes.
A new index of financial conditions – Econbrowser
Current financial conditions and future economic activity – Baseline Scenario