Mapping Heat in the U.S. Financial System

RePEc Short ID: pki4
ORCID iD: 0000-0003-0427-0131

Aikman, David; Kiley, Michael T.; Lee, Seung Jung; Palumbo, Michael G.; Warusawitharana, Missaka

Working Paper

Mapping Heat in the U.S. Financial System

Abstract: We provide a framework for assessing the build-up of vulnerabilities in the U.S. financial system. We collect forty-four indicators of financial and balance-sheet conditions, cutting across measures of valuation pressures, nonfinancial borrowing, and financial-sector health. We place the data in economic categories, track their evolution, and develop an algorithmic approach to monitoring vulnerabilities that can complement the more judgmental approach of most official-sector organizations. Our approach picks up rising imbalances in the U.S. financial system through the mid-2000s, presaging the financial crisis. We also highlight several statistical properties of our approach: most importantly, our summary measures of system-wide vulnerabilities lead the credit-to-GDP gap (a key gauge in Basel III and related research) by a year or more. Thus, our framework may provide useful information for setting macroprudential policy tools such as the countercyclical capital buffer.

Keywords: Early warning system; financial crisis; financial stability; financial vulnerabilities; heat maps; macroprudential policy; systemic risk; data visualization; countercyclical capital buffers;

JEL Classification: G01; G12; G21; G23; G28;