Financial Stress Regimes and the Macroeconomy

Abstract

Some …nancial stress events lead to macroeconomic downturns, while others appear to be isolated to …nancial markets. We identify …nancial stress regimes using a model that explicitly links …nancial variables to macroeconomic outcomes. The stress regimes are identi…ed using an unbalanced panel of …nancial variables with an embedded method for variable selection. Our identi…ed stress regimes are associated with corporate credit tightening and with NBER recessions. An exogenous deterioration in our …nancial condition index has strong negative e¤ects in economic activity, and negative ampli…cation e¤ects on in ‡ation in the stress regime. We employ a novel factor-augmented vector autoregressive model with smooth regime changes (FAST-VAR).