As it is witnessed in the last global financial crisis, financial markets and the real economy are increasingly becoming interconnected. Therefore, following financial condition is essential to understand the real economy. Financial conditions, conceptually, summarizes whether financial indicators such as interest rates, exchange rates, asset prices and credit conditions are being restrictive or accommodative on economic activity (Kara et. al., 2016) and financial conditions index (FCI) can be defined as an index that allows us to evaluate financial variables related with financial conditions in a simple fashion.
We choose 9 variables that can affect financial conditions in Turkey. By using a factor model, we determine variable weights that are used to construct the FCI. To be able to evaluate effects of these variables on the FCI easily, we form three groups from these variables: credit and money supply variables, financial markets variables and financial risk variables. In the table below, we present 9 variables, their weights and groups. As it can be inferred from the table, the most contribution to the FCI comes from financial market variables following by financial risk variables and credit and money supply variables. Negative weights indicate that the increase in variable value cause financial conditions to deteriorate and vice versa.
In the figure below, we present the FCI and its sub-indeces constructed by using variable weights. The FCI can affect industrial production up to 9 months lag. Values below 0 indicate poor financial conditions and the real economy is under high pressure. Values above 2 indicate favorable financial conditions and the real economy can grow above its potential.