In this paper, we measure the interdependence of three financial stress sub-indices (banking, securities and foreign exchange) for the major advanced economies during the 1981–2009 period using a single index based on the generalized variance decompositions developed by Diebold and Yilmaz (2012). We present spillover tables and indices that demonstrate financial stress innovations to and from other indices, in addition to spillover plots that show the dynamics of stress. Furthermore, we examine the relationship between financial stability and macroeconomic fundamentals by investigating the effects of financial stress on growth and on price levels. We proxy financial stability and monetary stability with a financial stress index (FSI) and a consumer price index (CPI), respectively, and examine their interdependence. Our findings indicate that the securities markets are the main net transmitters of stress to the other markets. In addition, up to 42.8% of the forecast error variance in all the markets examined emanates from stress spillovers. Finally, our findings highlight the interrelationship of financial and monetary stability.

At the beginning of the present century, the literature on financial integration focused on the benefits of increased integration. In particular, the literature emphasized that a well-integrated financial system allows economic agents to engage in risk sharing while enhancing the smooth transmission of monetary policy. However, the international financial crisis of 2007-08 and the euro area sovereign debt crisis of 2009-15, brought to the fore the flip side of increased financial integration – namely, that higher financial integration among national jurisdictions creates the potential for destabilizing cross-country spillovers of capital flows. The papers in this Special Issue address financial system vulnerabilities in the aftermath of the 2007-08 financial crisis and the 2009-15 euro area crisis. In particular, the papers assess (1) vulnerabilities arising from such factors as the liberalization of financial systems, cross-country contagion, and climate change, and (2) policy responses, including macroprudential supervision and quantitative easing, to financial instabilities.