Financial Stress and Economic Dynamics: The Transmission of Crises

47 Pages Posted: 2 Sep 2014

See all articles by Kirstin Hubrich

Kirstin Hubrich

Board of Governors of the Federal Reserve System

Robert J. Tetlow

Board of Governors of the Federal Reserve System

Multiple version iconThere are 3 versions of this paper

Date Written: August 18, 2014

Abstract

A financial stress index for the United States is introduced – an index that was used in real time by the staff of the Federal Reserve Board to monitor the financial crisis of 2008-9 – and the interaction with real activity, inflation and monetary policy is demonstrated using a richly parameterized Markov-switching VAR model, estimated using Bayesian methods. A "stress event" is defined as a period where the latent Markov states for both shock variances and model coefficients are adverse. Results show that allowing for time variation is economically and statistically important, with solid (quasi) real-time properties. Stress events line up well with financial events in history. A shift to a stress event is highly detrimental to the outlook for the real economy, and conventional monetary policy is relatively weak during such periods.

Keywords: nonlinearity, Markov switching, financial crises, monetary policy

JEL Classification: E44, C11, C32

Suggested Citation

Hubrich, Kirstin and Tetlow, Robert J., Financial Stress and Economic Dynamics: The Transmission of Crises (August 18, 2014). ECB Working Paper No. 1728. Available at SSRN: https://ssrn.com/abstract=2482374

Kirstin Hubrich (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Robert J. Tetlow

Board of Governors of the Federal Reserve System ( email )

20th and C Streets, NW
Washington, DC 20551
United States

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