Economic Vulnerability Is State Dependent

Abstract

This paper studies the impact of different levels of stress in the financial system on the real economy. The analysis shows that when financial conditions deteriorate from a situation of relative stability, the economic outlook becomes more pessimistic and uncertain. No increase in macroeconomic uncertainty is expected when financial conditions worsen from an already tighter than usual situation.

Additionally, past information on GDP growth turns out to be of crucial importance when it comes to studying and predicting economic vulnerability. Both findings have relevant forecasting and policy-making implications, and remain valid once other measures of the real economic activity are considered. The analysis relies on a new methodology for the dynamic modelling of multiple quantiles in the presence of an explanatory variable. This new approach exploits all past information on GDP growth and can accommodate a state dependent marginal effect of financial conditions.

Keywords: Economic Vulnerability, Macro-Financial Linkages, Growth-at-Risk, Score Driven Models