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Working Paper
Financial Conditions and Economic Activity: Insights from Machine Learning
Machine learning (ML) techniques are used to construct a financial conditions index (FCI). The components of the ML-FCI are selected based on their ability to predict the unemployment rate one-year ahead. Three lessons for macroeconomics and variable selection/dimension reduction with large datasets emerge. First, variable transformations can drive results, emphasizing the need for transparency in selection of transformations and robustness to a range of reasonable choices. Second, there is strong evidence of nonlinearity in the relationship between financial variables and economic ...