The Financial Stability Index estimated by the Institute of Financial Studies

In each issue of the Financial Studies Review, we update and publish the Financial Stability Index (FSI) of our Institute of Financial Studies, which tracks the correlation between economic growth and macroeconomic and financial factors in Romania. We constructed a composite index using a linear combination of financial variables that are considered to have a significant impact on economic activity. These financial variables are weighted with respect to their cumulated two quarters impulse response on GDP growth, as estimated by a VAR model.

 Developing such a composite index of financial stability or financial stress has two main utilities:

• The analysis of the correlation between financial variables and the real economy placed in the context of different historical episodes of financial crisis. Also, this correlation analysis reveals, in each period, the significant positive or negative contribution of each financial variable to real economic growth. Following this analysis, the FSI can measure the impact of economic and financial policy measures aimed at mitigating financial crises.
• The short-term prediction of real economic growth estimated by forecasting the next period evolution of the real economic activity (GDPt+1) using current period GDPt and FSIt and economic and financial variables in the FSIt composition.