Fundamental Analysis -Topic 13 GSFCI

The Goldman Sachs Financial Conditions Index:

A financial conditions framework is the right one for evaluating
monetary policy in the United States. The dominance of the capital
markets in the U.S. financial system means that the focus should be
on those factors that control the transmission of monetary policy to
the real economy such as private sector interest rates, the exchange
value of the dollar, and the valuation of the equity market.

The Goldman Sachs Financial Conditions Index (GSFCI) has had a
much tighter linkage with changes in economic activity in the 1990s
than other indicators such as the real federal funds rate or the broad
monetary aggregates. This has occurred, first, because of the growing
role of the stock market in the economy and, second, because markets
in general are now more anticipatory than in the past.

The GSFCI only contains four variables—real 3-month LIBOR, real
A-rated corporate bond yields, the real Goldman Sachs Trade-
Weighted Dollar Index (GSTWI), and the equity market
capitalization/GDP ratio. Despite this, it generally manages to capture
shifts in other financial variables that matter because these four
variables act as proxies for other financial variables that are not
explicitly included in the index.

Changes in the GSFCI foreshadow real GDP growth (with a lag of
about 3 quarters) on about a one-for-one basis. A one-point rise in the
GSFCI is followed by about a one-percentage-point reduction in the
growth rate within a year on average.

Similarly, an unanticipated 100-basis-point rise in the real federal
funds will tend to tighten the GSFCI by about one point, on average.
Thus, Fed officials might anticipate that a 100-basis-point hike in the
real federal funds that was not anticipated would trim the growth pace
by about one percentage point. Of course, these relationships have
significant variability. That is the reason why we developed a
financial conditions framework in the first place.

Goldman Sachs Global Economics
Paper No. 44
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GSFCI, Trough to Subsequent Peak

Trough to Peak
Dates Trough Peak Increase in bps

1961:Q1 - 1962:Q2 97.26 98.74 148
1968:Q4 - 1970:Q2 95.91 99.19 328
1972:Q1 - 1973:Q1 96.32 97.62 130
1975:Q2 - 1976:Q3 94.35 98.31 396
1977:Q2 - 1978:Q4 97.48 99.77 229
1980:Q3 - 1982:Q2 98.94 106.65 771
1983:Q2 - 1984:Q3 103.98 107.53 355
1987:Q1 - 1987:Q4 101.01 102.43 142
1993:Q4 - 1994:Q4 97.68 99.79 211


Goldman Sachs Global Economics
Paper No. 44
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Goldman Sachs Financial Conditions IndexSM*

GSFCI (index 1987-1995=100)
Dec 2005 100.18
Nov 2005 100.30
Oct 2005 100.31
Sep 2005 99.87

Goldman Sachs US Economics Analyst, Issue No: 05/50
December 16, 2005
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