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How Do Business and Financial Cycles Interact
TL;DR: In this article, the interactions between business and financial cycles using an extensive database of over 200 business and 700 financial cycles in 44 countries for the period 1960:1-2007:4.
Abstract: This paper analyzes the interactions between business and financial cycles using an extensive database of over 200 business and 700 financial cycles in 44 countries for the period 1960:1-2007:4. Our results suggest that there are strong linkages between different phases of business and financial cycles. In particular, recessions associated with financial disruption episodes, notably house price busts, tend to be longer and deeper than other recessions. Conversely, recoveries associated with rapid growth in credit and house prices tend to be stronger. These findings emphasize the importance of developments in credit and housing markets for the real economy.
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TL;DR: The authors highlighted the stylised empirical features of the financial cycle, conjectures as to what it may take to model it satisfactorily, and considered its policy implications in the discussion of policy.
Abstract: It is high time we rediscovered the role of the financial cycle in macroeconomics In the environment that has prevailed for at least three decades now, it is not possible to understand business fluctuations and the corresponding analytical and policy challenges without understanding the financial cycle This calls for a rethink of modelling strategies and for significant adjustments to macroeconomic policies This essay highlights the stylised empirical features of the financial cycle, conjectures as to what it may take to model it satisfactorily, and considers its policy implications In the discussion of policy, the essay pays special attention to the bust phase, which is less well explored and raises much more controversial issues
859 citations
TL;DR: In this article, a business cycle model with an endogenous collateral constraint that induces amplification and asymmetry in the responses of macro-aggregates to shocks is presented, and the evidence from Sudden Stops in emerging economies shows that financial crashes are generally followed by major economic crises.
Abstract: The evidence from Sudden Stops in emerging economies shows that financial crashes are generally followed by major economic crises. This paper explains this phenomenon as an equilibrium outcome of a business cycle model with an endogenous collateral constraint that induces amplification and asymmetry in the responses of macro-aggregates to shocks. Cyclical dynamics produce economic expansions during which the ratio of debt to asset values raises enough to hit the constraint, triggering a Fisherian deflation that causes a spiraling decline in credit and in the price and quantity of collateral assets. Output and factor allocations also fall because the collateral constraint cuts access to working capital financing. In the long run, precautionary saving makes Sudden Stops low probability events nested within normal cycles, as observed in the data.
815 citations
Journal Article•
TL;DR: In this article, the authors characterize the financial cycle using turning points and frequency-based filters and show that financial cycle peaks are very closely associated with financial crises, and that the length and amplitude of financial cycle have increased markedly since the mid-1980s.
Abstract: We characterize empirically the financial cycle using two approaches: analysis of turning points and frequency-based filters. We identify the financial cycle with the medium-term component in the joint fluctuations of credit and property prices; equity prices do not fit this picture well. We show that financial cycle peaks are very closely associated with financial crises and that the length and amplitude of the financial cycle have increased markedly since the mid-1980s. We argue that this reflects, in particular, financial liberalization and changes in monetary policy frameworks. So defined, the financial cycle is much longer than the traditional business cycle. Business cycle recessions are much deeper when they coincide with the contraction phase of the financial cycle. We also draw attention to the "unfinished recession" phenomenon: policy responses that fail to take into account the length of the financial cycle may help contain recessions in the short run but at the expense of larger recessions down the road.
508 citations
Cites result from "How Do Business and Financial Cycle..."
...…As our sample is not particularly large, the following results should be seen as indicative, even though the main insights are in line with Claessens et al (2011b).26 Table 9 Business cycle contractions and the phase of the financial cycle Full sample Pre-1985 Post-1985…...
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TL;DR: In this article, a macro-prudential policy could curb these credit cycles, both through raising the cost of maintaining risky portfolios and through an expectations channel that operates via banks' perceptions of other banks' actions.
Abstract: Credit cycles have been a characteristic of advanced economies for over 100 years On average, a sustained pick-up in the ratio of credit to GDP has been highly correlated with banking crises The boom phases of the cycle are characterised by large deviations in credit from trend A range of mechanisms can generate these effects, each of which has strategic complementarity between banks at its core Macro-prudential policy could curb these credit cycles, both through raising the cost of maintaining risky portfolios and through an expectations channel that operates via banks' perceptions of other banks' actions
430 citations
TL;DR: In this article, the authors analyze how changes in balance sheets of some 2800 banks in 48 countries over 2000-2010 respond to specific macro-prudential policies, and find that measures aimed at borrowers such as caps on debt to income and loan-to-value ratios, and limits on credit growth and foreign currency lending are effective in reducing leverage, asset and noncore to core liabilities growth during boom times.
404 citations
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Book•
01 Jan 1936
TL;DR: In this article, a general theory of the rate of interest was proposed, and the subjective and objective factors of the propensity to consume and the multiplier were considered, as well as the psychological and business incentives to invest.
Abstract: Part I. Introduction: 1. The general theory 2. The postulates of the classical economics 3. The principle of effective demand Part II. Definitions and Ideas: 4. The choice of units 5. Expectation as determining output and employment 6. The definition of income, saving and investment 7. The meaning of saving and investment further considered Part III. The Propensity to Consume: 8. The propensity to consume - i. The objective factors 9. The propensity to consume - ii. The subjective factors 10. The marginal propensity to consume and the multiplier Part IV. The Inducement to Invest: 11. The marginal efficiency of capital 12. The state of long-term expectation 13. The general theory of the rate of interest 14. The classical theory of the rate of interest 15. The psychological and business incentives to liquidity 16. Sundry observations on the nature of capital 17. The essential properties of interest and money 18. The general theory of employment re-stated Part V. Money-wages and Prices: 19. Changes in money-wages 20. The employment function 21. The theory of prices Part VI. Short Notes Suggested by the General Theory: 22. Notes on the trade cycle 23. Notes on mercantilism, the usury laws, stamped money and theories of under-consumption 24. Concluding notes on the social philosophy towards which the general theory might lead.
15,146 citations
TL;DR: The authors showed that bank deposit contracts can provide allocations superior to those of exchange markets, offering an explanation of how banks subject to runs can attract deposits, and showed that there are circumstances when government provision of deposit insurance can produce superior contracts.
Abstract: This paper shows that bank deposit contracts can provide allocations superior to those of exchange markets, offering an explanation of how banks subject to runs can attract deposits. Investors face privately observed risks which lead to a demand for liquidity. Traditional demand deposit contracts which provide liquidity have multiple equilibria, one of which is a bank run. Bank runs in the model cause real economic damage, rather than simply reflecting other problems. Contracts which can prevent runs are studied, and the analysis shows that there are circumstances when government provision of deposit insurance can produce superior contracts.
9,099 citations
Posted Content•
TL;DR: This article developed a dynamic general equilibrium model that is intended to help clarify the role of credit market frictions in business fluctuations, from both a qualitative and a quantitative standpoint, and the model is a synthesis of the leading approaches in the literature.
Abstract: This paper develops a dynamic general equilibrium model that is intended to help clarify the role of credit market frictions in business fluctuations, from both a qualitative and a quantitative standpoint. The model is a synthesis of the leading approaches in the literature. In particular, the framework exhibits a financial accelerator,' in that endogenous developments in credit markets work to amplify and propagate shocks to the macroeconomy. In addition, we add several features to the model that are designed to enhance the empirical relevance. First, we incorporate money and price stickiness, which allows us to study how credit market frictions may influence the transmission of monetary policy. In addition, we allow for lags in investment which enables the model to generate both hump-shaped output dynamics and a lead-lag relation between asset prices and investment, as is consistent with the data. Finally, we allow for heterogeneity among firms to capture the fact that borrowers have differential access to capital markets. Under reasonable parametrizations of the model, the financial accelerator has a significant influence on business cycle dynamics.
5,370 citations
"How Do Business and Financial Cycle..." refers background in this paper
...time, and thereby create general equilibrium effects (Bernanke et al., 1999; Kiyotaki and Moore, 1997)....
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...Many theoretical models emphasize the roles played by movements in credit and asset (house and equity) prices in shaping the evolution of macroeconomic aggregates over the business cycle (Bernanke et al., 1999; Kiyotaki and Moore, 1997)....
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TL;DR: This Time Is Different as mentioned in this paper presents a comprehensive look at the varieties of financial crises, and guides us through eight astonishing centuries of government defaults, banking panics, and inflationary spikes.
Abstract: Throughout history, rich and poor countries alike have been lending, borrowing, crashing--and recovering--their way through an extraordinary range of financial crises. Each time, the experts have chimed, "this time is different"--claiming that the old rules of valuation no longer apply and that the new situation bears little similarity to past disasters. With this breakthrough study, leading economists Carmen Reinhart and Kenneth Rogoff definitively prove them wrong. Covering sixty-six countries across five continents, This Time Is Different presents a comprehensive look at the varieties of financial crises, and guides us through eight astonishing centuries of government defaults, banking panics, and inflationary spikes--from medieval currency debasements to today's subprime catastrophe. Carmen Reinhart and Kenneth Rogoff, leading economists whose work has been influential in the policy debate concerning the current financial crisis, provocatively argue that financial combustions are universal rites of passage for emerging and established market nations. The authors draw important lessons from history to show us how much--or how little--we have learned. Using clear, sharp analysis and comprehensive data, Reinhart and Rogoff document that financial fallouts occur in clusters and strike with surprisingly consistent frequency, duration, and ferocity. They examine the patterns of currency crashes, high and hyperinflation, and government defaults on international and domestic debts--as well as the cycles in housing and equity prices, capital flows, unemployment, and government revenues around these crises. While countries do weather their financial storms, Reinhart and Rogoff prove that short memories make it all too easy for crises to recur. An important book that will affect policy discussions for a long time to come, This Time Is Different exposes centuries of financial missteps.
4,595 citations
Posted Content•
TL;DR: The authors constructs a simple neoclassical model of intrinsic business cycle dynamics in which borrowers' balance sheet positions play an important role and shows that the agency costs of undertaking physical investments are inversely related to the entrepreneur's/borrower's net worth.
Abstract: This paper constructs a simple neoclassical model of intrinsic business cycle dynamics in which borrowers' balance sheet positions play an important role. The critical insight is that the agency costs of undertaking physical investments are inversely related to the entrepreneur's/borrower's net worth. As a result, accelerator effects on investment emerge: Strengthened borrower balance sheets resulting from good times expand investment demand, which in turn tends to amplify the upturn; weakened balance sheets in bad times do just the opposite. Further, redistributions or other shocks that affect borrowers' balance sheets (as in a debt-deflation} may have aggregate real effects.
4,286 citations