The Anatomy of Financial Vulnerabilities and Crises

88 Pages Posted: 20 Feb 2017

See all articles by Seung Jung Lee

Seung Jung Lee

Board of Governors of the Federal Reserve System

Kelly Posenau

University of Chicago - Booth School of Business

Viktors Stebunovs

Board of Governors of the Federal Reserve System

Date Written: 2017-02

Abstract

We extend the framework used in Aikman, Kiley, Lee, Palumbo, and Warusawitharana (2015) that maps vulnerabilities in the U.S. financial system to a broader set of advanced and emerging economies. Our extension tracks a broader set of vulnerabilities and, therefore, captures signs of different types of crises. The typical anatomy of the evolution of vulnerabilities before and after a financial crisis is as follows. Pressures in asset valuations materialize, and a build-up of imbalances in the external, financial, and nonfinancial sectors follows. A financial crisis is typically followed by a build-up of sovereign debt imbalances as the government tries to deal with the consequences of the crisis. Our early warnings indicators which aggregate these vulnerabilities predict banking crises better than the Credit-to-GDP gap at long horizons. Our indicators also predict the severity of banking crises and the duration of recessions, as they take into account possible spill-over and amplification channels of financial stress to from one to another sector in the economy. Our indicators are of relevance for macroprudential and crisis management, in part, because they perform better than the Credit-to-GDP gap and do not suffer from the gaps econometric flaws.

Keywords: Credit-to-GDP gap, Crisis management, Financial vulnerabilities, Early warning system, Financial crises, Banking crises, Currency crises, Macroprudential policy

JEL Classification: C82, D14, G01, G12, G21, G23, G32, H63

Suggested Citation

Lee, Seung Jung and Posenau, Kelly and Stebunovs, Viktors, The Anatomy of Financial Vulnerabilities and Crises (2017-02). FRB International Finance Discussion Paper No. 1191, Available at SSRN: https://ssrn.com/abstract=2920455 or http://dx.doi.org/10.17016/IFDP.2017.1191

Seung Jung Lee (Contact Author)

Board of Governors of the Federal Reserve System ( email )

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

Kelly Posenau

University of Chicago - Booth School of Business ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States

Viktors Stebunovs

Board of Governors of the Federal Reserve System ( email )

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

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