Measuring financial conditions in poorer countries

Why care about finance?

After all, economic output is just the number of people working multiplied by the average number of hours worked multiplied by average output per hour. If you want to raise living standards the trick is to increase output per hour enough that people can consume more stuff even as they work fewer hours. These are problems of social policy and technological investment, not capital markets and banks.

But it’s the financial sector that tends to drive the booms and busts of the cycle. Changes in lending standards and asset prices affect decisions to save and spend, which in turn affect employment and production. It’s not a coincidence that American recessions are overwhelmingly driven by large drops in spending on motor vehicles and housing — big-ticket items bought on credit. Anyone with responsibility for smoothing the vicissitudes of the cycle has to care about financial conditions.

For countries such as the US, the challenge is how to interpret the wealth of data regularly produced by the markets and the statistical agencies. Banks and other research shops aggregate these diverse data sources into indices, as do several of the regional Federal Reserve Banks. Most notable among them is probably the Chicago Fed, which has an index based on 105 separate components. In practice they tend to look like a measure of high-yield credit spreads.

In other countries, especially poorer ones, the challenge is more fundamental. There aren’t nearly as much data with the quality, frequency, and history as in the rich world. Signals that work well in some places might work less well in places with fundamentally different financial systems. (See, for example, China’s partly-inverted sovereign yield curve.) Combine this with relatively little investor interest in places such as Tanzania or St Vincent and the Grenadines and it makes sense why people haven’t created financial conditions indices for those countries comparable to the ones in the US.

David…

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