The Chicago Fed has created a new indicator that more accurately predicts the onset of financial crises and recessions — and there’s good news: we’re nowhere close to either one.
The index is actually just a distilled version of the Chicago Fed’s weekly National Financial Conditions Index, which tracks 100 indicators of risk, credit, and leverage in the U.S.
This new indicator takes the combination among those 100 that best align with previous periods of financial distress and separates them out.
They call it the “nonfinancial leverage indicator” (which we’ll abbreviate as the NLI).
They then plot the NLI (in black) against a two-year-ahead threshold point at which, on average, the probability of a crisis became inevitable (and add a reference line showing a basic private-credit-to-GDP ratio indicator, in blue).
Here is the result.
Photo: Chicago Fed
The indicators creators, Scott Brave and R. Andrew Butters, write:
Instances where nonfinancial leverage falls above both thresholds are characteristic of the run-up to many of the most severe crises and deepest recessions (e.g., those in 1973–75, 1980, 1981–82, and 2007–09), while instances where nonfinancial leverage falls in between the two thresholds are generally more consistent with less pronounced periods of financial stress and shallower recessions (e.g., those in 1990–91 and 2001).
As you can see, the NLI is at very low levels relative to its historical average — it’s about where we were in the mid-90s.
Those were the days.
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