On the Direction of Causality between Business and Financial Cycles

Ilias Tsiakas and Haibin Zhang
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Haibin Zhang: Anheuser-Busch InBev, 125 W 24th St, New York, NY 10011, USA

JRFM, 2023, vol. 16, issue 10, 1-26

Abstract: This paper investigates whether business cycles cause financial cycles or vice versa. We also assess whether the US plays a leading role in causing the domestic business and financial cycles of other countries. The literature has established that business and financial cycles are linked through several channels such as credit constraints, the real effects of financial information and the reversal of overoptimistic expectations. Our analysis evaluates the direction of Granger causality using a novel approach based on the mixed-frequency vector autoregression model for the G7 countries. Our approach exploits the fact that real economic activity measured by industrial production is observed at a higher frequency than aggregate credit. We find strong evidence of bidirectional causality between the business and financial cycles, especially in recessions. Furthermore, the US is a global leader since the US business cycle significantly affects other countries’ business cycles, especially in terms of expansions.

Keywords: business cycle; financial cycle; Granger causality; mixed-frequency vector autoregression (search for similar items in EconPapers)
JEL-codes: C E F2 F3 G (search for similar items in EconPapers)
Date: 2023
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Citations: View citations in EconPapers (1)

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