SF Fed: Creating An Early Warning System For Crises Could Be Difficult

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The San Francisco Federal Reserve released an economic letter Monday, saying that creating an early-warning system that would predict the timing of potential world financial crises would be a daunting task because of the different factors that contribute to such problems in different countries.

"If the causes of the crises differ across countries, there is little hope of finding a common statistical model to predict them," wrote San Francisco Fed researchers Andrew Rose and Mark Spiegel.

The letter noted that economists have not previously been successful at predicting the timing of financial crises, even though they have made improvements in predicting the severity of such crises across countries.

Rose and Spiegel also wrote that measurable pre-existing conditions on the relative severity of the current financial crisis differed among various world countries, increasing the difficulty of being able to create an effective early-warning system.

"Almost none of our posited variables [GDP growth, percentage changes in stock markets] are statistically significant determinants of crisis severity," they wrote. "While we can model the incidence of the crisis reasonably well, we are unable to link the severity of the crisis across countries to its causes."

A letter written earlier this month by San Francisco researcher Bharat Trehan suggested that there were economic indicators based on asset market developments [credit gaps, asset prices] that could provide advance warnings of "potentially dangerous financial imbalances."

Rose and Spiegel, however, also gave an alternative explanation for the difficulty of being able to create an effective early-warning system; they said that the 2008 financial crisis could have been the result of a "global shock," meaning that the crisis varied across countries varied in a way that was unrelated to country-specific "regulatory, financial and macroeconomic 'fundamentals.'

"The same [difficulty in finding a common statistical model] holds in cases of common or contagious shocks if a country's ability to withstand it is unrelated to fundamentals," they wrote.

The San Francisco Federal Reserve released an economic letter Monday, saying that creating an early-warning system that would predict the timing of potential world financial crises would be a daunting task because of the different factors that contribute to such problems in different countries. "If the causes of the crises differ across countries, there is little hope of finding a common statistical model to predict them," wrote San Francisco Fed researchers Andrew Rose and Mark Spiegel. (Market News Provided by RTTNews)