We do not often blog on theoretical topics like economic models. We prefer to engage in the practical applications in banking that can translate to direct and immediate benefits for our bank readers. However, in the case of the Taylor Rule, we see an intersection of the theoretical and practical that is worth discussing. In 1992, John Taylor invented an interest rate forecasting model, and this same individual is now being considered for the Federal Reserve chair position, or possibly the vice chair position. Regardless of how the Federal Rese
Knowing where we are in the business cycle is a key input into looking at projected probabilities of default for loan credit underwriting as well as future loan prepayment speeds. If done correctly, banks want to tighten underwriting standards as the economy inflates and loosens them during the troughs of the cycle. Unfortunately, most banks do it the complete opposite loosening standards due to competition when things are overheated and tightening them at the trough.
Yesterday, we covered a set of economic indicators that have proven to be unreliable at predicting the future of rates, credit, loan or deposit growth. The subject is topical as many banks are working through their budget forecasts and instead of just relying on history, many banks seek to increase the accuracy of their predictions by utilizing these indicators. One way to do this is to incorporate forecasts of these economic indicators and then use that as the basis for fine tuning bank budget variables.
Given that it is forecasting time again for next year’s budget, banks often use a variety of economic indicators to help forecast demand for credit, liquidity, and inflation. Often time, we will see many of these indicators in ALCO reports or strategic plans. We have tried a great many indicators and have tracked the effectiveness of each one. Today, we will cover some of the more unreliable ones, while tomorrow we will cover the ones that work.