1 Financial Stress and its Impact on Economic Activity: Evidence from Jamaica

This paper developed Financial Stress Indexes for Jamaica (JFSI) using monthly data from January 2005 to July 2013 for the equity, foreign exchange and money markets by utilizing a simple aggregation method, a market weighted approach and principal components analysis (PCA). All three indexes were successful in identifying historical periods of financial stress for Jamaica. In addition, deterioration in the indexes during periods of stress was mainly attributed to volatility in the stock and foreign exchange markets. However, the unweighted index exceeded other indexes during key periods and was chosen as the most appropriate measure of financial stress. In addition, OLS estimation was utilized to examine the effect of financial stress episodes, as measured by the unweighted index, on real GDP growth. Other variables captured in the estimation included the spread between loan and deposit rates, growth in the fiscal balance, the exchange rate and growth in net exports. Findings showed that following a financial stress episode, real GDP growth will moderately decrease three months into the future