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Financial Conditions and Downside Risk to Economic Activity in Australia

Author

Listed:
  • Luke Hartigan

    (Reserve Bank of Australia)

  • Michelle Wright

    (Reserve Bank of Australia)

Abstract
We apply the growth-at-risk framework to the Australian economy. This allows us to estimate how important current financial conditions are in explaining future downside risk to key macroeconomic variables. As such, it provides a way to quantify the economic costs of financial instability. In order to implement this framework, we develop a new financial conditions index for Australia and show that it correlates closely with previous episodes of financial instability. We find that more restrictive financial conditions play an important role in explaining downside risk to growth in both GDP and employment and upside risk to changes in the unemployment rate. Our measure of financial conditions is, however, less useful for explaining risks to growth in household consumption and business investment. Overall, the framework provides a useful characterisation of the relationship between financial stability and economic activity in Australia.

Suggested Citation

  • Luke Hartigan & Michelle Wright, 2021. "Financial Conditions and Downside Risk to Economic Activity in Australia," RBA Research Discussion Papers rdp2021-03, Reserve Bank of Australia.
    • Handle: RePEc:rba:rbardp:rdp2021-03
    DOI: 10.47688/rdp2021-03
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    References listed on IDEAS

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    Cited by:

    1. Frederic Boissay & Fabrice Collard & Cristina Manea & Adam Shapiro, 2023. "Monetary tightening, inflation drivers and financial stress," BIS Working Papers 1155, Bank for International Settlements.
    2. Pedro Gomis-Porqueras & Romina Ruprecht & Xuan Zhou, 2023. "A Financial Stress Index for a Small Open Economy: The Australian Case," Finance and Economics Discussion Series 2023-029, Board of Governors of the Federal Reserve System (U.S.).

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    More about this item

    Keywords

    downside risk; dynamic factor model; financial conditions; quantile regression;
    All these keywords.

    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods
    • C55 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Large Data Sets: Modeling and Analysis
    • E27 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Forecasting and Simulation: Models and Applications
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

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