The Simpler the Better: Measuring Financial Conditions for Monetary Policy and Financial Stability

42 Pages Posted: 15 Aug 2020

See all articles by Simone Arrigoni

Simone Arrigoni

Trinity College (Dublin) - Department of Economics

Alina Bobasu

European Central Bank (ECB)

Fabrizio Venditti

European Central Bank (ECB)

Date Written: August, 2020

Abstract

In this paper we assess the merits of financial condition indices constructed using simple averages versus a more sophisticated alternative that uses factor models with time varying parameters. Our analysis is based on data for 18 advanced and emerging economies at a monthly frequency covering about 70% of the world’s GDP. We use four criteria to assess the performance of these indicators, namely quantile regressions, Structural Vector Autoregressions, the ability of the indices to predict banking crises and their response to US monetary policy shocks. We find that averaging across the indicators of interest, using judgemental but intuitive weights, produces financial condition indices that are not inferior to, and actually perform better than, those constructed with more sophisticated statistical methods.

Keywords: banking crises, financial conditions, quantile regressions, spillovers, SVARs

JEL Classification: E32, E44, C11, C55

Suggested Citation

Arrigoni, Simone and Bobasu, Alina and Venditti, Fabrizio, The Simpler the Better: Measuring Financial Conditions for Monetary Policy and Financial Stability (August, 2020). ECB Working Paper No. 20202451, Available at SSRN: https://ssrn.com/abstract=3671498

Simone Arrigoni

Trinity College (Dublin) - Department of Economics ( email )

Arts Building
Room 3014
Dublin
Ireland

Alina Bobasu (Contact Author)

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Fabrizio Venditti

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

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