Stress In Financial Markets

In recent months, public debate has renewed among economists and policy makers on the importance of trailing financial market stress. Financial distress in 2007 & 2008 embarked the down-turn in the global economy by boosting the cost of credit and making businesses, household, and financial institutions highly cautious. After more than 15 months of undertaking unprecedented measures to support financial sectors, removing liquidity from the economy and unwind special lending programs become a need to ensure a return to sustainable growth with low inflation.

In previous recoveries, the decision to tighten policy was based mainly on the strength of business & consumer spending and the size of upward pressure on prices and wages. In this recovery, additional element in the exist strategy will be determining if financial stress is no longer high to endanger economic recovery. As financial conditions improve various measures of financial stress (like interest rate spread or LIBOR-OIS spread) that central banks monitor may give mixed signals. To overcome such inconsistency among different measures, economists in the Federal Reserve Bank in Kansas City and in St. Louis constructed separately two different measures (indices) for financial market stress each uses large number of financial variables.

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