The dollar, bank leverage and real economic activity: an evolving relationship
Focus
The paper studies how financial conditions affect real economic activity. It examines, in particular, the relationship between the role of the dollar exchange rate and indicators compiled from surveys of corporate purchasing activity around the world, as well as indicators of global trade growth. A special focus is on how this relationship has evolved since the Great Financial Crisis (GFC) compared with the pre-crisis period.
Contribution
Financial conditions affect real economic activity, and this relationship has changed since the Great Financial Crisis of 2007-09, not least because of significant changes that have taken place in the pattern of financial intermediation. Our paper contributes to the literature examining the greater role of the dollar as a determinant of global economic activity. It sheds light on this issue by examining how changes in the financial sector since the GFC have influenced the empirical relationship between global purchasing managers' indices, world trade and indicators of global financial conditions, with a special focus on the broad dollar exchange rate index.
Findings
We find that the relationship between financial market variables and real economic activity has changed since the GFC. The influence of the dollar on global manufacturing and trade has increased, while that of the implied volatility embedded in equity options has decreased. In addition, the relationship between the dollar and real activity has changed: since the GFC, a stronger dollar has been associated with weaker trade and manufacturing outside the United States, contrary to pre-crisis experience and the theory of trade competitiveness. We review several explanations for these results, focusing on changes in financial intermediation since the GFC and the role of dollar financing for firms participating in global supply chains.
Abstract
The interest in how financial conditions affect real economic activity has grown since the Great Financial Crisis (GFC), not least because some of the mechanisms at play in the financial sector may have changed. We shed light on this issue by examining the empirical relationship between global Purchasing Managers' Indices, world trade and indicators of global financial conditions, with a special focus on the broad dollar index. We show that the influence of the dollar on real economic activity and global trade seems to have increased since the GFC, while that of the VIX has decreased.
JEL classification: C5, E2, F3, F4, F6
Keywords: financial conditions, economic activity, world trade, dollar exchange rate, bank leverage, purchasing managers' indices, nowcasting, global supply chains
