# Appendix IV. Linkages between business and financial cycles: an overview of empirical studies

Using various methodologies and measures to proxy cycles, a number of studies have examined the features of business and financial cycles and the aggregate linkages between such cycles. They have pointed out the procyclical nature of financial markets and provided the broad patterns describing the linkages between business and financial cycles. This Appendix reviews these studies for the three most important market segments: credit, equity and housing.<sup>62</sup>

## Credit market cycles and business cycles

The study of credit cycles has a history that goes back to Mills (1867) at least. Most of the early work in this area employed qualitative approaches and considered the extreme versions of these cycles: booms and busts (or crunches) (see Keynes (1936), Galbraith (1954), Shiller (1989, 2000) and Sinai (1993); Niehans (1992) reviews very early work on credit cycles (Juglar (1862)). A number of studies also consider specific credit crunches in the United States and other countries (see Wojnilower (1980, 1985), Owens and Schreft (1995), Cantor and Wenninger (1993) and Helbling et al (2011)). Using US data going back to 1875, Bordo and Haubrich (2010) document that credit disruptions appear to exacerbate cyclical downturns. A number of studies also consider the important role played by credit in driving business cycles. Using VAR models, Meeks (2012) examines the role of credit shocks in explaining US business cycles and finds that such shocks play an important role during financial crises but a somewhat smaller role during “normal” business cycles.

Recent studies apply a variety of quantitative approaches to cross-country data to analyse episodes of credit booms and crunches. Mendoza and Terrones (2008), for example, use a “thresholds method” to identify credit booms in 48 countries over the period 1960–2006. They find that booms generally coincide with above-trend growth in output, consumption and investment during the build-up phase and below-trend growth of those variables in the unwinding phase. During the build-up phase, a surge in private capital inflows is accompanied by a deterioration of current account positions (see also Gourinchas et al (2001), Schularick and Taylor (2012)). Other researchers (such as Castro and Kubota (2013) and Dell’Ariccia et al (2016)) also study the determinants of credit booms’ length.

## Cycles in asset (house and equity) prices and business cycles

Booms and busts in asset prices have also been a major area of research. Borio and Lowe (2002), using an aggregate index of asset price (equities, and residential and commercial property), define booms as periods during which asset prices deviate from their trends by specified amounts. They also consider the interaction between developments in asset prices and credit. They report that there are substantial declines in house prices and residential investment during housing busts (after episodes of booms) in 16 advanced economies. This

> 62 For additional references on the literature covering the linkages between business and financial cycles see Rebelo (2005), Claessens et al (2009, 2011, 2012a), Siregar and Lim (2011), Guarda and Jeanfils (2012), Hubrich et al (2013), Borio (2014), De Rezende (2014), Große Steffen (2015), Hubrich and Tetlow (2015), Kose and Terrones (2015), Hartmann et al (2015), Abbate (2016), Abildgren (2016), Jordà et al (2016, 2017), Bluwstein (2017) and Gandré (2017).

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