RDP 9704: Financial Aggregates as Conditioning Information for Australian Output and Inflation 5. Conclusions

This paper tests whether financial aggregates are useful as information variables for policy makers in two distinct frameworks. The first technique employs a liberal criterion to examine this issue, seeing if completely certain information on the future course of financial aggregates improves in-sample forecasts of real output growth and inflation. The aggregates in general do not satisfy this criterion, with one exception: certain knowledge of future credit growth could have improved the prediction of real output growth, particularly in 1990 and 1991. This of course begs the question of whether credit can be accurately forecast. Further analysis of the results suggests, as has been found in other research, that credit growth is typically endogenously determined by real output growth. However, in the 1990–92 period, credit appears to have been more informative than simply a variable moving in response to real output growth. This suggests that credit growth is more informative in periods of financial restructuring.

The second method that we employ examines the information content of the financial aggregates in single-equation frameworks for predicting real output growth and inflation. In this exercise, using well-specified models of inflation and real output growth, we find a statistically significant contribution from the growth in credit to real output growth in a specification using OECD GDP as the foreign output measure. Results using US GDP as a foreign output measure offer no significant results for any of the financial aggregates.

We suggest that a financial aggregate is useful for policy-making if it provides significant information for real output growth and/or inflation that is robust across empirical methods. Our results suggest that while financial aggregates contain some information about future growth in real output, that information is generally captured more precisely by other variables. Once we control for these other variables, there appears to be no robust relationship between real output growth and inflation and any of the financial aggregates that can be exploited in a regression framework for policy analysis. In general, the financial aggregates become just another set of corroborating information variables. The one exception to this conclusion is that in periods of major financial restructuring, changes in credit growth may provide important information in assessing the pace of future output growth.