Systemic Financial Stress and Macroeconomic Amplifications in the United Kingdom*

Abstract

We develop a daily composite index of financial stress for the United Kingdom over 50 years, the UKFSI. The index includes market stress indicators based on their incremental information to capture financial crises. During the COVID-19 crisis, financial stress peaks but remains less severe than during the Global Financial Crisis. The UKFSI is used in a threshold vector autoregression to differentiate the economic dynamics between tranquil and stressful periods. We highlight the importance of nonlinearities that amplify shocks. But we find no evidence of financial shocks contributing to the COVID-19 crisis, possibly reflecting effective policy interventions. I. IntroductionOver the past five decades, the UK financial sector has been buffeted by a few major shocks, which have highlighted the importance of macro-financial linkages. On the one hand, the severe economic and financial meltdown during the global financial crisis (GFC) was amplified within the banking sector. On the other hand, the spread of the COVID-19 pandemic unleashed profound economic and financial stress, but the shock was partly absorbed by a more resilient banking sector and unprecedented policy support.Against this backdrop, we develop a daily systemic financial stress index for the United Kingdom, the UK Financial Stress Index (UKFSI). We demonstrate its importance for assessing the transmission of financial shocks and the amplification of small shocks during stressful periods.The UKFSI is a daily-from 1971 onwards-composite index of systemic financial stress, that is, it tracks periods characterized by higher volatilities, valuation losses and a JEL Classification numbers: C31, C54, G01, G15. *The authors thank Andy Blake, David Aikman, Lee Foulger and colleagues who participated in Bank of England seminars on the subject. The views expressed are those of the authors and do not necessarily reflect those of the Bank of England (its Monetary Policy Committee, Financial Policy Committee or Prudential Regulatory Committee) nor those of the Bank of Canada. All errors remain our own.

Non‐majoritarian institutions, media coverage, and “reinforced accountability”

“…Finally, we focus on financial stability, the Bank's second main objective. We rely on the UK Financial Stress Index (UKFSI), a recently developed measure that captures systemic financial stress and is available till June 2020 (Chatterjee et al., 2022). The UKFSI is a composite index with higher values in months characterized by “higher volatilities, valuation losses and a widening of risk spreads that occur simultaneously across a wide range of asset markets (the equity, government bond, foreign exchange, corporate bond and money markets)” (2022, p. 1).…”

Review of periodical literature for 2022: (vi) post‐1945

“…Lastly, some articles describe new indices that may be helpful for researchers exploring 1945–present. Caldara and Iacoviello develop an index of geopolitical risk for the UK, the United States, and Canada from 1900 on the basis of newspapers, O'Reilly and Murphy create new indices of state capacity from 1789 to 2018 for many countries, and Chatterjee et al. construct a daily composite index of financial stress for the UK from 1971.…”

Nonlinear Transmission of Financial Shocks: Some New Evidence

“…Balke (2000), Hubrich and Tetlow (2015), and Chatterjee et al. (2022), using various types of regime‐switching VARs, find that the effects of financial shocks are magnified under conditions of credit‐rationing or financial stress. This evidence is broadly consistent with the third kind of nonlinearity in BS.…”