June 7, 2019
Estimates of the Financial Cycle for Advanced Economies
Until recently, macroeconomic theory provided at most a small role for the financial system to influence the real economy. This changed with the collapse of Lehman Brothers in 2008 and the financial crisis which followed. Financial quantities such as outstanding credit and house prices are now believed to have real macroeconomic effects. In order to study these effects we need to quantify the influence of the financial system. The financial cycle, characterized by long period cyclical movements in financial variables, may provide such a measure.
In this research, we therefore propose a bi-variate state space model of outstanding credit and house prices that enables us to identify a single shared financial cycle with a typical period of 15 to 20 years. We obtain estimates of the financial cycle for a panel of 18 advanced economies which for most countries starts before 1960 and for eight even starting before 1930. These cycles are used in Estimating the Impact of the Financial Cycle on Fiscal Policy to investigate whether the financial cycle influences the effectiveness of government spending.
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