With the national unemployment rate running below 4 percent, the possibility that an overheated economy could lead to financial imbalances, which in turn could generate or amplify economic distress, has become more salient. We explore the link between indicators of financial imbalances and macroeconomic performance, focusing on the experience of the United States. Our approach involves a statistical analysis of the link between measures of economic slack and financial system vulnerability. We study bivariate time-series relationships between different measures of economic slack and systemic financial vulnerability, relying on conventional measures of the business and financial cycles. In an accompanying note, The Relationship between Macroeconomic Overheating and Financial Vulnerability: A Narrative Investigation, we follow a narrative approach to review historical episodes of significant financial imbalances and examine whether these episodes were linked to macroeconomic overheating. Neither approach highlights a strong direct link between macroeconomic overheating and increased financial vulnerability.
Board of Governors of the Federal Reserve System
October 12, 2018