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The Relationship between Macroeconomic Overheating and Financial Vulnerability: A Quantitative Exploration Accessible Data
Figure 1: Business Cycles and Credit Cycles
This figure contains two panels. Both panels contain time series from 1960 to 2018, and 6 shaded time regions that denote periods of economic overheating. The top panel, titled "Economic Slack Measures," plots the FRB estimate of unemployment gap, and the CBO estimate of output gap. The unemployment gap is computed as the negative of a deviation of the unemployment rate from the FRB NAIRU. It is positive during periods of economic overheating. The output gap is computed as a percentage deviation of real GDP from real potential GDP. The panel shows that the output gap closely follows the dynamics of the unemployment gap; that is, the two series are highly positively correlated.
The bottom panel, titled "Financial Vulnerability Measure: Credit-to-GDP Gap," plots the credit-to-GDP gap. This gap is obtained from a one-sided Hodrick-Prescott filter with a smoothing parameter of 400,000. The series shows time variability that drastically increases since the late 1980s, with a notable increase from around 0 to almost 10 percent from mid to late 1980, a persistent decline until mid 1990s, a subsequent increase to its highest level of almost 15 percent in 2008, followed by a persistent decline to its lowest level around minus 16 percent between 2013 and 2016, and an increase since then to levels around minus 8 percent in 2018. The credit to gdp gap pattern does not show any obvious relation with the shaded regions of economic overheating.
Note: The orange shading in Economic Slack Measures denotes periods of economic overheating. Output gap is computed as a percent deviation of real GDP from real potential GDP. Unemployment gap is computed as negataive of a deviation of the unemployment rate from the FRB NAIRU estimate.
The orange shading in Financial Vulnerability Measure: Credit-to-GDP Gap denotes periods of economic overheating. The Credit Gap is derived from a one-sided HP filter with a smoothing parameter set at 400,000.
Figure 2. Average Duration of Business Cycles and Credit Cycles in the United States
The figure displays Burns-Mitchell diagrams for the credit-to-GDP gap and the measures of economic slack (output gap and unemployment gap). The horizontal axis, centered on 0, is the number of quarters (duration) before and after a peak. The vertical axis, from negative 6 to positive 1, is the amplitude of the cycle. The average duration of the credit cycle, measured by the typical distance from peak to trough, is shown to be 28 quarters and is substantially longer than the average duration of the business cycle (10 quarters).
Note: The figure displays Burns-Mitchell diagrams for the credit-to-GDP gap and the measures of economic slack. The average duration of the credit cycle, measured by the typical distance from peak to trough, is shown to be 28 quarters and is substantially longer than the average duration of the business cycle (10 quarters).
Figure 3: Conditional Forecasts, Forecasts for the Credit-to-GDP Gap (one-sided) Conditional on the Output Gap
The figure displays the actual historical series of the credit-to-gdp gap since 1995 to 2018, and forecasts of this gap conditional on the output gap at three different points of time (labeled A, B, and C) with their respective 90% confidence intervals. The solid red lines show forecasts for the credit-to-GDP gap assuming knowledge of the path of the output gap over the following four quarters. The forecast starting in 2018:Q1 is conditional on the CBO forecasts of the output gap made in April 2018 over the following four quarters. The shaded blue area denotes the onset of the Financial Crisis. Points A and B allow us to compare the actual and forecast values of the credit to gdp gap. In both cases, the forecast is visually very close to the actual value. However, the confidence interval includes both increases and declines in the gap. Point C in 2018:Q1 coincides with the last observed actual data point for the gap in the series. The forecast gap rapidly increases from around negative 9 to around negative 6. However, the confidence interval includes both increases and declines in the gap.
Note: The solid red lines show forecasts for the credit-to-GDP gap assuming knowledge of the path of the output gap over the following four quarters. The forecast starting in 2018:Q1 is conditional on the CBO forecasts of the output gap made in April 2018 over the following four quarters. The shaded blue area denotes the onset of the Financial Crisis.