The predictive content of financial cycle measures for output fluctuations

6 June 2011

The financial cycle refers to fluctuations in perceptions and attitudes about financial risk over time. It is often marked by swings in credit growth, asset prices, terms of access to external funding, and other financial developments. A single measure that summarised such indicators would simplify analysis of the financial cycle, with benefits for both systemic risk assessment and stabilisation policy. It is not obvious, however, how best to select and combine the many potentially relevant indicators or how the usefulness of the resulting measure might be assessed. One criterion is predictive power. This special feature reviews the power of three differently composed measures to predict output fluctuations up to two years ahead. One of the measures is found to have substantial predictive content for output forecasting at short horizons. However, this result seems to arise mainly from the inclusion of indicators strongly related to actual financial system stress, rather than from swings in more generalised perceptions and attitudes about financial risk.

JEL classification: E32, E51