'Real Time' Early Warning Indicators for Costly Asset Price Boom/Bust Cycles: A Role for Global Liquidity

Abstract

We test the performance of a host of real and financial variables as early warning indicators for costly aggregate asset price boom/bust cycles, using data for 18 OECD countries. A 'real time' signaling approach is used to predict asset price booms that have serious real economy consequences. We use a loss function to rank the indicators given policy makers' relative preferences with respect to type I and II errors and suggest a new measure for assessing the usefulness of indicators. Global measures of liquidity, in particular a global private credit gap, are the best performing indicators and display forecasting records, which are informative for policy makers interested in timely reactions to growing financial imbalances.