An Investigation of Co-Movement of Financial Stability Index with Macro-Prudential Indicator through Wavelet Analysis

The present study aims at developing an aggregate financial stability index by using banking sector indices to assess financial stability and examine if the variable of creditto- GDP gap corresponds to its long-term trend which represents the macro-prudential indicator has co-movement with the built financial stability index? To this end, monthly banking balance sheet data were collected from the Central Bank of the Islamic Republic of Iran from March 2007 to March 2017. Co-movement of two time series was assessed at two dimensions of time and frequency through wavelet analysis. It can be observed that there is a greater relationship between the two variables at short-term and mediumterm. In the short-term, there is a negative correlation between financial stability and the representative of the macro-prudential variable. The increase of the credit-to-GDP gap results in a decrease in financial stability while these variables are positively correlated at medium-term. An increase in the credit-to-GDP gap increases financial stability, whereas such a relationship cannot be observed for the long-term. Thus, it seems necessary to adopt a macro-prudential policy more at medium term.