Incorporating Macro-Financial Linkages into Forecasts Using Financial Conditions Indices: The Case of France

Abstract

How can information on financial conditions be used to better understand macroeconomic developments and improve macroeconomic projections? We investigate this question for France by constructing country-specific financial conditions indices (FCIs) that are tailored to movements in GDP, investment, private consumption and exports respectively. We rely on a VAR approach to estimate the weights of the financial components of each FCI, including equity market returns (which turn out having a relatively strong weight across all FCIs), private sector risk premiums, long-term interest rates, and banks' credit standards. We find that the tailored FCIs are useful as leading indicators of GDP, investment, and exports, and as a contemporaneous indicator of private consumption. Credit volumes turn out to be lagging indicators of growth. The indices inform us on macro-financial linkages in France and are used to improve the accuracy of quarterly forecasting models and high-frequency 'nowcast' models. We show that FCI-augmented models could have significantly improved forecasts during and after the global financial crisis.

Keywords: Europe, France, Forecasting, financial conditions index, macro-financial linkages, vector auto-regression, refers to exports volume of goods, General, Forecasting and Simulation

JEL Classification: E27, C30, E30, E10