Sowing the Seeds of Financial Imbalances: The Role of Macroeconomic Performance

FEDS Working Paper No. 2020-028

29 Pages Posted: 16 May 2020

See all articles by Elena Afanasyeva

Elena Afanasyeva

Board of Governors of the Federal Reserve System

Sam Jerow

Board of Governors of the Federal Reserve System

Seung Jung Lee

Board of Governors of the Federal Reserve System

Michele Modugno

Board of Governors of the Federal Reserve System

Multiple version iconThere are 2 versions of this paper

Date Written: March 5, 2020

Abstract

The seeds of financial imbalances are sown in times of buoyant economic growth. We study the link between macroeconomic performance and financial imbalances, focusing on the experience of the United States since the 1960s. We first follow a narrative approach to review historical episodes of significant financial imbalances and find that the onset of financial disturbances typically occurs when the economy is running hot. We then look for evidence of a statistical link between measures of macroeconomic conditions and financial imbalances. In our in-sample analysis, we find that strong economic growth is followed by a build-up of financial imbalances across all dimensions of the National Financial Conditions Index. In our out-of-sample analysis, we find that the link between strong economic performance and increases in nonfinancial leverage is particularly strong and robust. Using a structural VAR identified with narrative sign restrictions, we also demonstrate that business cycle shocks are important drivers of nonfinancial leverage.

Keywords: Non-financial Leverage, Financial Imbalances, Financial Stability, Forecasting, VAR, Sign Restrictions, Narrative

JEL Classification: C32, G21, N22

Suggested Citation

Afanasyeva, Elena and Jerow, Sam and Lee, Seung Jung and Modugno, Michele, Sowing the Seeds of Financial Imbalances: The Role of Macroeconomic Performance (March 5, 2020). FEDS Working Paper No. 2020-028. Available at SSRN: https://ssrn.com/abstract=3581453 or http://dx.doi.org/10.2139/ssrn.3581453

Elena Afanasyeva (Contact Author)

Board of Governors of the Federal Reserve System ( email )

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

Sam Jerow

Board of Governors of the Federal Reserve System ( email )

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

Seung Jung Lee

Board of Governors of the Federal Reserve System ( email )

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

Michele Modugno

Board of Governors of the Federal Reserve System ( email )

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

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