Expected worsening or improving financial instability and the 2008 financial crisis

• Build up index of expected financial instability for both individual G20 economy and country groups.
• Compute a variety of indices based on different view of imbalance adjustment approaches.
• Argue that the link between external sector imbalances and the onset of the 2008 crisis may be more tenuous than claimed.

We focus on the external sector component of financial instability and link changes in country imbalances to GDP growth rates in ways to produce indices of expected worsening or improving financial instability at different points in time. Our results suggest that depending upon the index used and the base date chosen for comparison, different implications emerge for the linkage between external sector imbalances, perceived future instability and hence the possible onset of a financial crisis. The implication we drawn is that links between imbalances and best policy response to 2008 crisis asserted by the G20 may be more tenuous than claimed.