Incorporating Macro-Financial Linkages into Forecasts Using Financial Conditions Indices: The Case of France
37 Pages Posted: 18 Jan 2018
Date Written: December 2017
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
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