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We are grateful for helpful comments from Frank Diebold, Sandra Eickmeier, Charles Engel, Marty Feldstein, Michael Klein, Lucrezia Reichlin, Ken West, Frank Warnock, and especially our discussants, Jeff Frankel, Steve Cecchetti, and Carmen Reinhart. We wish to thank participants of the 2010 NBER ISOM Conference, 2011 AEA Meetings, the Turkish Economic Association International Conference on “The Global Economy after the Crisis: Challenges and Opportunities,” and other workshops where earlier related work was presented. We thank David Fritz and Ezgi Ozturk for providing outstanding research assistance.
Starting with Fisher (1933), a number of researchers emphasize the importance of financial cycles for the real economy. Sinai (1992) reviews some of the early literature. The importance of credit for business cycles has been an intensive area of research, e.g., Bernanke, Gertler, and Gilchrist (1996), and Gilchrist and Zakrajsek (2008). Recent research on credit and housing cycles using micro data includes Ivashina and Scharfstein (2010) and Mian and Sufi (2010). For a discussion about equity price cycles, see Malkiel (2007). For the history of financial crises, see Kindleberger and Aliber (2005) and Reinhart and Rogoff (2009). In addition to numerous papers on the dynamics of financial markets, recent books (e.g., James, 2009, and Ferguson, 2009) analyze the global financial crisis from different angles through the lens of history.
Archetypical is the credit cycle, or the relative ease of access to credit by borrowers. A typical credit cycle starts when funds are easy to borrow, a period maybe characterized by low (real) interest rates, rising collateral values and easing lending requirements. This period is followed by tightening in the availability of funds, when interest rates go up, collateral values fall and loan provision becomes stricter, leading fewer people to borrow.
The countries are: Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Japan, Netherlands, New Zealand, Norway, Portugal, Spain, Switzerland, Sweden, the United Kingdom, and the United States. We do not include the period of the recent global financial crisis, since we want to focus on complete financial cycles.
For a broader perspective of financial cycles, it could be useful to consider alternative measures of credit and asset prices. For example, some recent papers (e.g., Chari, Christiano, and Kehoe, 2008; and Cohen-Cole et al., 2008) highlight the importance of going beyond aggregate measures (for example, differentiating credit to corporations from credit to households) to study the dynamics of credit markets. Unfortunately, such disaggregated credit series are not available for a large number of countries over the sample period we analyze.
See Pagan and Sossounov (2003), Gomez and Perez de Gracia (2003), and Hall, McDermott and Tremewan (2006). While useful to employ alternative asset price series, it is not possible to put together a more comprehensive database that includes consistent measures across different countries.
Moreover, it constitutes the guiding principle of the Business Cycle Dating Committees of the National Bureau of Economic Research (NBER) and of the Center for Economic Policy Research (CEPR) in determining the turning points of U.S. and European business cycles. However, it is not easy to reproduce exactly the dates of cycles identified by the NBER Committee as it involves a judgmental approach considering various dimensions of activity, not just output, and employs monthly data. See further Stock and Watson (2010) and Sinai (2010) for recent examples of various dating methods.
The algorithm we employ is known as the BBQ algorithm since it is applied to quarterly data. It has been widely used in earlier studies in the context of business cycles (King and Plosser, 1994; Watson, 1994; Artis, Kontolemis, and Osborn, 1997) as well as cycles in equity and housing prices (Pagan and Sossounov, 2003; Hall, McDermott and Tremewan, 2006).
House price data start in 1970 for all countries, except Austria (1986:3), Belgium (1985:1), Greece (1993:4), and Portugal (1988:1).
We also study the full distributions of the durations of the downturns and upturns. These confirm our summary findings here (for details, see Claessens, Kose, and Terrones, 2011).
A long list of studies examines why asset prices are more volatile than fundamentals (see Bikhchandani and Sharma (2000) for a review of this literature).
We also study the concordance of national cycles with those in the U.S. and find those to be quite similar to overall concordance, suggesting that there are strong linkages between the U.S. and global financial markets. The results at the country level are available from the authors upon request.
Some other studies focus on the lead-lag characteristics between cycles in asset markets. For example, Borio and McGuire (2004) report that housing price peaks lag equity price peaks by up to 2-year and that the lag length is negatively related to changes in short-term interest rates.
See Bekaert and Harvey (2000), Goetzman and others (2005), and Quinn and Voth (2008) on the role of financial linkages. Edwards, Biscarri and Perez de Gracia (2003) find that the concordance of cycles across stock markets has increased over time, especially for Latin American countries after liberalization.
Bordo and Jeanne (2002) identify episodes of booms-busts in asset prices by considering deviations of moving averages of growth rates in asset prices from their long-run averages.
We focus on patterns in the year-on-year growth in each variable over a 6-year window—12 quarters before and 12 quarters after a peak of an expansion. All panels include the median growth rates, i.e., the typical behavior, along with the top and bottom quartiles.
These models provide the formal underpinnings of Fisher’s (1933) “debt-deflation” mechanism of how a decline in net worth induced by falls in asset prices leads borrowers to reduce their demand for credit along with their spending and investment.
Although most of this literature uses simple duration models with no covariates, studies also consider whether different indicators of activity (including leading economic indicators, private investment, oil prices, and U.S. recession dates) help explain the duration of cycles (see Diebold and Rudebusch, 1990; Ohn, Taylor and Pagan, 2004; and Castro, 2008).
An early attempt to examine duration dependence in stock prices is Lunde and Timmermann (2004). They report evidence of duration dependence in equity price contractions (bear markets) in the United States during the period 1885-1997.
Kose et al. (2010) survey the literature analyzing the impact of financial integration on the likelihood of crises. Frankel and Saravelos (2010) provide a detailed analysis on how various leading indicators help explain the crosscountry incidence of the 2008-09 financial crisis.
These results are available from the authors upon request. We also run multivariate models, where we include various factors at the same time. The results are broadly consistent with those reported here. In addition to the duration and amplitude of downturns, we also examine the factors driving the slope and cumulative loss of such episodes, with results again mostly confirming the importance of the explanatory variables discussed here.
Cecchetti (2006) finds evidence that housing booms worsen growth prospects and that equity booms have little impact on expected mean and variance of macroeconomic performance, although they do aggravate the adverse outcomes. In a related paper, Cecchetti and Lee (2008) study the impact of equity and house price booms on the extreme tails of the distributions of fluctuations in output and prices.