Working Paper

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


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 non financial leverage.

Keywords: Economic performance; Nonfinancial leverage; Financial imbalances; Financial stability; VARs; Sign restrictions; Narrative; Forecasting;

JEL Classification: C32; G21; N22;

https://doi.org/10.17016/FEDS.2020.028

Access Documents

Authors

Bibliographic Information

Provider: Board of Governors of the Federal Reserve System (U.S.)

Part of Series: Finance and Economics Discussion Series

Publication Date: 2020-04-07

Number: 2020-028

Pages: 29 p.