Correcting 'Beyond the Cycle:' Accounting for Asset Prices in Structural Fiscal Balances

How Do Public Debt Cycles Interact with Financial Cycles?

“…The longer period of debt expansions is in line with evidence on longer economic recovery following financial booms (IMF, 2015). Inclusion of all three financial dummies simultaneously in Column VI does not affect the signs of coefficients, but only house price coefficients stays significant due to collinearity driven by high synchronization of credit and asset price markets (Liu et al, 2015). By contrast, financial cycles have no significant impact on debt contractions.…”

“…For financial cycles, we use quarterly data on equity price, house price, and domestic credit from Liu et al (2015). These variables were used for analyzing the relationship between financial and business cycles by Claessens et al (2009Claessens et al ( , 2012Claessens et al ( , and 2014.…”

“…Given the close association between the financial markets, real economy and public finances, public debt cycles are also expected to be influenced (IMF, 2015;Jorda et al, 2015). While there is growing evidence on the importance of financial shocks for fiscal accounts (Afonso et al, 2011;Benetrix and Lane, 2013;Budina et al, 2015;Liu et al, 2015), empirical analysis of public debt cycles and their association with financial cycles has not been performed systematically in the past. The purpose of this paper is to contribute to the growing literature on the financial markets-fiscal policy nexus and analyze the main features of public debt cycles, with a specific focus on the impact of boom and bust in the financial markets.…”

“…The indirect impact is channeled through the economy. For instance, financial downturns result in higher risk premia, disruption of supply of credit, reduction of consumption and investment, squeeze in aggregate demand, which in turn leads to a permanent reduction of revenues and consequent increase in public deficits and debt (Liu et al, 2015;IMF, 2015).…”