Financial stress and its relationship with the macroeconomy - the case of Ireland

This paper develops a financial stress index (FSI) for Ireland, which includes variables related to the housing market, in an attempt to identify turning points in the Irish financial cycle. The index can be used to provide early warnings of financial market stress. We use a Markov Switching model to identify and date states or regimes of financial stress. This may serve to assist policy makers in identifying when the economy is entering or exiting a period when macro-financial risk is more acute. Finally, we examine how macroeconomic variables react to changes in financial market conditions under different phases of financial stress.