Global Financial Cycles and Macroeconomic Linkages

Abstract

Failure to sufficiently model financial variables and a possible time-varying relationship between the financial and macroeconomic sectors have been identified as two major shortcomings of the most prominent macroeconomic models. To this end, I examine time-varying linkages between the financial and macroeconomic sectors across countries. I examine the existence of global financial cycles and study if the financial sector is an important source of shocks for the global macroeconomic sector. I find evidence of quantitatively significant global cycles in credit and equity price. The cycles are stronger in the years leading up to and following the crisis. Global house-price cycle is mostly driven by idiosyncratic components before 2000, however, the house-price cycle is significant after the turn of the century. I do not find quantitatively significant joint global cycle encompassing all financial variables. I then study time-varying contribution of the global financial shocks as well as financial shocks originating in the US, the UK and Germany. I find evidence of time variation in the size and the transmission of the financial shocks, especially the equity-price and house-price shocks. I find evidence of increase in both the transmission and the size of the shocks during various financial crises, especially during the recent financial crisis. The contribution of the global and the US house-price shocks increase significantly during the recent financial crisis. The combination of increase in the size and the transmission of the house-price shocks in unprecedented. The model can explain the large degree of heterogeneity in the effect of a financial shock across countries.