Financial and economic stability as ‘two sides of a coin’

Abstract

Purpose– The purpose of this paper is to provide a different context for considering issues of financial stability and instability, with reference to economic growth and price stability in particular.Design/methodology/approach– This paper pursued an empirical exploration of six pillars of financial stability, based on a data set for the UK extending from 1985 (Q1) to 2008 (Q2), through the construction of a vector error correction model, including an impulse response function analysis.Findings– The findings show a strong association between the financial and economic stability even in a non-crisis regime. This includes, for example, a strong association exists between the stock market and the real economy; exchange rate appreciation may not provide for long-term real economic growth; inflation does not contribute to real economic growth, both the sensitivity of the economy to yields and a significant lag in transitional effects from financial markets to the real sector; a positive role of credit creation within a non-crisis regime; exchange rate appreciation affects purchasing power; and potential points of linkage between sovereign debt activity and general price levels.Research limitations/implications– The findings should be considered in the context of a concept of the economy as fundamentally dynamic and subject to complex cumulative processes.Practical implications– The findings indicate there is a role for state oversight and intervention within a non-crisis regime based on the complexity of possible interactions that may undermine financial and price stability, with consequences for their association with economic growth.Originality/value– The study provides a new perspective for considering issues of financial stability and instability.