Financial Factors and the Business Cycle

Abstract

We study how financial factors shape and interact with the U.S. business cycle through a unified empirical approach where we jointly estimate financial and business cycles as well as identify their underlying drivers using a medium-scale Bayesian Vector Autoregression. First, we show, both in reduced form and when we identify a structural financial shock, that variation in financial factors had a larger role in driving the output gap post-2000 and a more modest role pre-2000. Our results suggest that the financial sector did play a role in overheating the business cycle pre-Great Recession. Second, while we document a positive unconditional correlation between the credit cycle and the output gap, the correlation of the lagged credit cycle and the contemporaneous output gap turns negative when we condition on a financial shock. The sign-switch suggests that the nature of the underlying shocks may be important for understanding the relationship between the business and financial cycles.

Impact of Financial Factors on the Economic Cycle Dynamics in Selected European Countries

“…In the empirical analysis, in accordance with relevant works, such as Tamási and Világi (2011) or Berger et al (2020), two types of econometric models were used. On the one hand, Bayesian VAR (B-VAR) models were used to identify the effect caused by shocks in the financial system at the level of each state individually; on the other hand, panel data models were used to identify whether there were significant differences in impact caused by the level of development of the states.…”

“…In the same area, a similar result was also discovered for the USA economy by Yan and Huang (2020) using wavelet functions but also VAR-type (vector autoregression) models. Berger et al (2020) analyzed the effect of financial factors on the economic cycle by means of Bayesian VAR models. The results of their study showed that the impact of financial factors on the output gap was much stronger in the period after 2000 than in the period before this year.…”