Financial conditions index as a leading indicator of business cycles in Turkey

Abstract

A financial conditions index (FCI) is an instrument that is developed using some financial variables in order to predict future output and/or inflation. Therefore, some studies in the literature examine the relationship between FCI and output gap/growth to determine whether the FCI is a leading indicator of business cycles. This study aims at investigating the relationship between output gap and FCI for Turkey by utilizing quarterly data covering the period 2005:1–2015:3. In other words, the study examines whether the FCI can be a leading indicator of business cycles in Turkey. For this purpose, the study, first, presents an FCI that has been recently developed for Turkey and reveals that the FCI is able to present the developments in the Turkish economy and in the world. Second, the study employs unit root tests and cointegration tests. The study finally performs vector autoregressive (VAR) analysis and the bootstrap Granger causality test to examine the relationship between FCI and output gap in Turkey. Both VAR analysis and the bootstrap Granger causality test indicate that the FCI has predictive power in forecasting future output gap in Turkey. Based on these findings, this study yields that the FCI in this study can be used as a leading indicator of business cycles in Turkey.