Financial Variables and Developments in the Real Economy

Abstract

This article examines whether financial variables are useful as leading indicators of the output gap and mainland GDP growth. Financial variables may be leading indicators either because they (a) are priced on the basis of expectations, (b) affect the economy with a lag or (c) are published earlier and more frequently than GDP figures. Moreover, they are not subject to significant revisions. We find that house prices, equity prices, credit growth, money growth, real exchange rates, real short-term interest rates and the difference between long- and short-term interest rates can serve as leading indicators of GDP growth and/or the output gap. The output gap is most strongly correlated with growth in domestic credit to enterprises (lagged 0–4 quarters) and cyclical fluctuations in equity prices (lagged 2–5 quarters). We include effects of equity prices and enterprise credit in an econometric forecasting model of GDP. The model takes into account that equity prices and credit growth may influence each other and that changes in GDP may feed back to financial variables. The model fits well and has stable coefficients.