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The core of this paper is an econometric estimation of the relation between financial stress and a number of macroeconomic variables (consumption, real GDP, investment, unemployment). This estimation is done on Turkish quarterly data for the period 2002-2021 using threshold vector autoregression (i.e., TVAR). The paper observes the non-linear trade-off between financial stress and macroeconomic indicators. The effect of financial stress appears to be adverse when the stress level is already at a higher level. During high stress episodes, any further increase in financial stress drags economic growth down and the effect appears to be prolonged in nature. Consumption and investment growth also moderate due to a higher stress level. Furthermore, the forecast error decomposition indicates sustained contribution of financial stress impeding growth prospects over the forecast horizon. The findings corroborate with the financial friction mechanism. As borrowing constraint tightens during a high stress regime, the effect of financial stress moderates economic activities. Lastly, the paper extends a local projection approach for estimating a threshold VAR model as a robustness check.

Early warning indicators (EWIs) of banking crises should ideally be judged on how well they function in relation to the choice issue faced by macroprudential policymakers. However, the effectiveness of EWIs depends upon the strength of the predicting power, stability, and timeliness of the signal. Using a balanced panel of 6 countries’ experience with banking and currency crises in recent times, this paper evaluates the effectiveness of EWIs using Receiver Operating Characteristics. Following the drivers of the banking crisis and currency crisis, the paper evaluates the effectiveness of aggregate credit growth, sectoral deployment of credit along and other macroeconomic indicators generally used as EWI. The paper observes that credit disbursements to non-financial sectors and the central government provides stable signals about systemic risks. Further debt service ratio, interbank rates and total reserves are also found to be useful in predicting these crises. Lastly, the effective EWIs are combined using shrinkage regression methods to evaluate the improvement of signal strength of the combination of EWIs. The predictive power of the combination of EWIs provides better signal strength in predicting the macroprudential crisis.

In this paper, we aim to analyze empirically how economic activity reacts to the financial stress shocks depending on the stress regime in Turkey. Using quarterly data, the effect of financial stress is examined using two threshold vector autoregression model (TVAR) for consumption, investment and real GDP by using financial stress index, credit growth and inflation rate as endogenous variables. The paper proposes local projection approach for estimating threshold VAR model as robustness check to overcome the data limitations. The main result of this paper is that the effect of financial stress on consumption, investment, and real GDP, such as magnitude and significance, vary greatly depending on the financial stress regime. The paper finds that financial stress is found to affect economic growth when the stress level is already high. This corroborates with the effectiveness of credit channel in the financial friction mechanism.On the contrary, the financial stress does not affect real economic activities to significantly during low stress regime. The effect of financial stress impairs consumption and investment growth during high stress regime which leads to slow down of economic activities.

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