'Real Time' Early Warning Indicators for Costly Asset Price Boom/Bust Cycles: A Role for Global Liquidity

58 Pages Posted: 22 Apr 2009

See all articles by Lucia Alessi

Lucia Alessi

European Central Bank (ECB)

Carsten Detken

European Central Bank (ECB)

Multiple version iconThere are 3 versions of this paper

Date Written: March 31, 2009

Abstract

We test the performance of a host of real and financial variables as early warning indicators for costly aggregate asset price boom/bust cycles, using data for 18 OECD countries between 1970 and 2007. A signalling approach is used to predict asset price booms that have relatively serious real economy consequences. We use a loss function to rank the tested indicators given policy makers' relative preferences with respect to missed crises and false alarms. The paper analyzes the suitability of various indicators as well as the relative performance of financial versus real, global versus domestic and money versus credit based liquidity indicators. We find that global measures of liquidity are among the best performing indicators and display forecasting records, which provide useful information for policy makers interested in timely reactions to growing financial imbalances, as long as aversion against type I and type II errors is not too unbalanced. Furthermore, we explore out-of-sample whether the most recent wave of asset price booms (2005-2007) would be predicted to be followed by a serious economic downturn.

Keywords: Early Warning Indicators, Signalling Approach, Leaning Against the Wind, Asset Price Booms and Busts, Global Liquidity

JEL Classification: E37, E44, E51

Suggested Citation

Alessi, Lucia and Detken, Carsten, 'Real Time' Early Warning Indicators for Costly Asset Price Boom/Bust Cycles: A Role for Global Liquidity (March 31, 2009). ECB Working Paper No. 1039. Available at SSRN: https://ssrn.com/abstract=1361492

Lucia Alessi (Contact Author)

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Carsten Detken

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany
0049 69 13440 (Phone)
0049 69 1344 6000 (Fax)

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