Assessing vulnerabilities to financial shocks in some key global economies

This paper describes a quantitative, data-driven method to assess vulnerabilities in a range of countries. We provide country-level vulnerability indices which can be used to gauge the level of fragility at any point in time. In particular, our results suggest that in the run-up to the Global Financial Crisis, vulnerabilities rose to extremely high levels in the United States, but were only a little above average in Europe and had actually receded across much of Asia. The picture has changed dramatically during the recovery, however, with vulnerabilities close to record-highs by end-2015 in some of the Asian economies. We document numerous practical challenges that arise when developing such a toolkit, the main one being to know the trend — the ‘neutral’ level — of a financial variable (for example credit-to-GDP). In that context, one important contribution of this paper is to document the robustness of vulnerability measures to different judgements about the trend level of financial variables. We find that for most countries results are fairly robust to different views of the underlying trend, but importantly that this robustness is not universal. In particular, at the moment differing views of what ‘the new normal’ is suggest dramatically different assessments of the level of fragility in the United States and South Korea.