Financial Conditions Start to Tighten
Financial conditions have started to tighten sharply again.</br></br>Or so says a new financial conditions index produced by a group of academic and Goldman Sachs economists*. And that's important, because financial conditions are a significant determinant of overall economic performance.</br></br>Financial conditions indexes already exist. In fact there's a plethora that have been developed by investment banks and economic agencies or consultancies. They try to measure the degree to which changes in credit availability, interest rates, risk premia, money supply, wealth effects and other factors are likely to influence future economic activity. Analysis shows they don't work particularly well as predictors of real economic activity.</br></br>The new index tries to get around these problems by, among other things, broadening the data series included and by trying to strip out the effects of past changes in economic activity that affect the financial variables. In other words, it's looking for evidence of financial shocks rather than the normally dynamics of financial indicators, which tell us plenty about the past but not a lot that's new about the future.</br></br>Having done that, the new indicator diverges substantially from the existing ones. Established FCIs show that general financial conditions are back to normal or even better than normal. The new index points to a big deterioration during the past quarter, retracing nearly half of last year's big rebound.