Abstract
We study how current financial cycle variables (house prices, credit-to-GDP, and share prices) influence the entire distribution of future GDP growth. Changes in financial cycle variables affect borrowers’ and lenders’ balance sheets, resulting in the lower quantile of GDP growth to be more sensitive to the financial accelerator, while the upper quantiles are relatively stable over horizons. We also find the combination of the rapid growth in asset prices and higher leverage amplifies the effect of asset prices on the downside of GDP growth. Moreover, we rely upon financial cycles constructed using two popular methods to investigate the impact on the distribution of GDP growth. The findings are consistent with the impact of financial cycle variables. In addition, we execute a series of robustness tests and find that the results survive. Our results suggest that policymakers should consider the risk-return tradeoff between economic growth and financial stability in the term structure emanating from macro-financial linkages. Specifically, policies regarding credit expansion and contraction combined with the regulation of house and equity prices should be calibrated to the state of GDP growth.
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