The paper analyses the relationship between financial markets and economic growth in Italy by using indicators of financial stress to forecast the probability and the severity of future economic slowdowns. The forecasts are based on non-linear regressions that take into account the potential strengthening of the correlation between financial markets and the real economy during financial stress episodes.
The negative correlation between financial conditions and economic growth strengthens significantly when the financial markets are volatile. This mechanism, however, does not improve the real-time forecasts on the direction of the economic cycle. The estimates of the impact of financial conditions are very volatile and they overestimate the magnitude of the contractions in the economic activity that followed the 2008 and 2011-12 crises.
