Financial Variables and Macroeconomic Forecast Errors
Following the Great Recession of 2007-09, much research focused on the measurement and predictive power for macroeconomic activity of financial variables meant to capture different aspects of the macro-financial landscape. Most of this work has centered on evaluating the importance of financial variables (primarily asset prices) in forecasting real economic activity.
The authors of this paper set out to assess the connection between finance and the macroeconomy by examining how a battery of financial variables fares in predicting macroeconomic forecast errors. The developed evidence sheds light on what types of financial linkages have been “missing” in many macro forecasting models to date. Such evidence could help inform policymakers’ and economists’ agendas for developing financial indicators and macroeconomic models that are better attuned to relevant financial developments.