Financial Stability Note: Growth at Risk & Financial Stability

• Potential for weak or negative economic growth in the future is influenced by current financing conditions and the gradual build-up of financial vulnerabilities.
• Macroprudential policy aims to build resilience in the system to reduce the likelihood of those weak or negative economic outcomes happening.
• Structural characteristics of Ireland’s economy or financial system make it more exposed to potential weak growth outcomes, compared with other countries.

The Central Bank of Ireland has today (13 April 2021) published a Financial Stability Note, written by Martin O’Brien and Michael Wosser entitled “Growth at Risk & Financial Stability”. 

A fundamental part of financial stability analysis and policy is considering the magnitude of potential downside risks related to the gradual build-up of financial vulnerabilities or instances of acute financial market stress.  In this paper the authors use Growth at Risk (GaR) as a methodology for understanding how financial conditions and the level of financial vulnerabilities contribute to the possibility of future episodes of weak economic growth.

The authors show that the likelihood and severity of future weak or negative economic growth in Ireland rises during periods where risks to financial stability are growing. In particular, they show that near-term tail risks are heavily influenced by prevailing financial market conditions, but that medium-horizon risks are more dependent on systemic financial vulnerabilities, such as when credit growth is excessive. 

The analysis also shows that the severity of the COVID-19 shock, from a macro-financial perspective, is less than the previous financial crisis, in part because it was not preceded by a build-up of systemic financial vulnerabilities and the more resilient starting point of the economy and financial system.

The analysis also suggests that structural characteristics of Ireland’s economy or financial system make it more exposed to potential weak growth outcomes, compared with other countries in the sample.  The authors also examine how macroprudential policy, an important contributor to system-wide resilience, can be better informed by tracking developments in the severity and likelihood of weak or negative economic outcomes made possible by a GaR framework.

Notes

The library of Financial Stability notes published by the Central Bank is available on our website.