Building a Financial Conditions Index for the Euro Area and Selected Euro Area Countries: What Does It Tell Us about the Crisis?

Abstract

Information on all of the papers published in the ECB Working Paper Series can be found on the ECB's website, http://www.ecb. europa.eu/pub/scientific/wps/date/html/index.en.html Macroprudential Research NetworkThis paper presents research conducted within the Macroprudential Research Network (MaRs). The network is composed of economists from the European System of Central Banks (ESCB), i.e. the national central banks of the 27 European Union (EU) Member States and the European Central Bank. The objective of MaRs is to develop core conceptual frameworks, models and/or tools supporting macro-prudential supervision in the EU.The research is carried out in three work streams: 1) Macro-financial models linking financial stability and the performance of the economy; 2) Early warning systems and systemic risk indicators; 3) Assessing contagion risks.MaRs is chaired by Philipp Hartmann (ECB). Paolo Angelini (Banca d'Italia), Laurent Clerc (Banque de France), Carsten Detken (ECB), Simone Manganelli (ECB) and Katerina Šmídková (Czech National Bank) are workstream coordinators. Javier Suarez (Center for Monetary and Financial Studies) and Hans Degryse (Katholieke Universiteit Leuven and Tilburg University) act as external consultants. Fiorella De Fiore (ECB) and Kalin Nikolov (ECB) share responsibility for the MaRs Secretariat.The refereeing process of this paper has been coordinated by a team composed of Gerhard Rünstler, Kalin Nikolov and Bernd Schwaab (all ECB).The paper is released in order to make the research of MaRs generally available, in preliminary form, to encourage comments and suggestions prior to final publication. The views expressed in the paper are the ones of the author(s) and do not necessarily reflect those of the ECB or of the ESCB.

Financial cycles around the world

“…In particular, following the logic that a financial cycle is a single latent factor driving activity in a given financial segment, f t consists of one factor, 23 modelled as an AR(1) process in Equation ( 1) to capture its persistence, given our conjecture that accumulation of financial imbalances is a persistent self-reinforcing process. 24 As differencing the data to ensure stationarity may possibly erode meaningful information contained in the level series (also noted in Angelopoulou, Balfoussia, & Gibson, 2014;English et al, 2005), in addition to the conventional stationary versions of dynamic factor models used as a baseline, for robustness, we also estimate non-stationary versions using the data in levels. The input signal variables are transformed before entering a respective state-space model as follows: (a) For the "stationary" versions, the variables are differenced (year-on-year change or percentage change, depending on the nature of a variable) 25 ; (b) all variables are standardized (demeaned and divided by their standard deviation), which ensures that the variances of individual variables contribute to the variance of the estimated latent factor symmetrically, and the differences in their measurement scale and historical country-specific magnitudes do not bias the estimates.…”

Firm Investment and Financial Conditions in the Euro Area: Evidence from Firm-Level Data

“…Our paper builds on Angelopoulou, Balfoussia and Gibson (2014) and Balfoussia and Gibson (2016) who construct and employ this financial conditions index to explore the real macroeconomic effects of changes in credit conditions. They report inter alia a significant causal relationship between easing financial conditions and aggregate investment in the euro area.…”

Financial Conditions and Economic Activity: The Potential Impact of the Targeted Longer-Term Refinancing Operations (TLTROs)

“…In Angelopoulou et al (2014), we construct a financial conditions index by conducting a principal component's analysis with more than 20 variables, including not only interest rates but also spreads, quantities and survey data. We show how the index moves both in the pre-crisis period and the post and how it provides a good narrative of the crisis.…”

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This paper explores the relationship between financial conditions and real economic activity in the euro area as a whole and for Greece in particular. We use a financial conditions index (see Angelopoulou et al, 2014) which is constructed using a wide range of prices, quantities, spreads and survey data in line with theory. We update the indices and use them within a VAR framework to estimate the potential impact of the TLTROs on aspects of economic activity.

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“…There is some evidence that when financial conditions are bad, the lack of finance does act as a drag on investment.English et al (2005) focus on forecasting GDP, investment and inflation in Germany, the UK and the US. They construct a financial conditions index in a manner similar toAngelopoulou et al (2014). They then add it to the forecasting equations.…”