Procyclical Behavior Research Articles

Is money velocity pro-cyclical? The case of India

Monetary targeting served as a useful tool for conducting monetary policy until 1980s, but the instability in the relationship between money and nominal income led to its abandonment by most economies. One way of measuring this relationship is money velocity, defined as the ratio of nominal income to money. The purpose of the present study is to show that if short-run cyclical factors are accounted for, money velocity function becomes stable and thus any change in monetary aggregates will lead to predictable change in nominal income and therefore inflation. In such a scenario, monetary targeting can serve as a useful tool in the conduct of monetary policy. The study utilizes quarterly data from 1996:Q2 to 2020:Q1 and time series methodology to conduct empirical analysis. Findings show that money velocity and all its identified determinants exhibit pro-cyclical behaviour. After accounting for these determinants, money velocity has been found to be stable. The direction of causality runs from money velocity to rate of interest to investment to GDP. Thus, when formulating monetary and fiscal policies, policymakers can monitor the short-term cyclical patterns in money velocity as an indicator of forthcoming expansionary or contractionary conditions in the economy to design effective policies.

Foreign direct investment inflows and business cycles

According to the stylized facts of the empirical real business cycle literature, investment is a procyclical variable, i.e. it co-moves with business cycles. Consequently, foreign direct investment's procyclical behavior is hypothesized and tested in this paper. A big sample of 74 (and 65 in the extended model) countries is used, and the hypothesis is tested on quarterly data with an average length of 90 periods, i.e. 22 years. Business cycles are identified by the Hodrick-Prescott filter, and the use of high-frequency data makes the results more precise and reliable. Using fixed effect regressions first the procyclicality of domestic investment is demonstrated, then the cyclical behavior of foreign direct investment is tested. Data shows that FDI is also procyclical. This result is robust, as it takes into account potential confounding variables. The paper's conclusion is that there is significant co-movement between foreign direct investment inflows and the recipient countries' business cycles.

Caution: Do Not Cross! Distance to Regulatory Capital Buffers and Corporate Lending in a Downturn

AbstractWhile banks are expected to draw down regulatory capital buffers in case of need during a crisis, we find that banks kept at a safe distance from regulatory buffers during the pandemic by procyclically reducing corporate lending. By exploiting granular credit register data, we show that banks with little capital headroom above their buffers reduced credit supply and that this behavior was amplified for banks that entered the crisis with larger undrawn credit lines. Affected firms were unable to fully rebalance their borrowing needs with other banks, although public guarantees mitigated banks' procyclical behavior and its real effect at the firm level. These findings raise concerns that the capital buffers introduced by Basel III may not be as countercyclical as intended.

Worldwide fluctuations in carbon emissions: Characterization and synchronization

Coordinated and cooperative efforts among international actors are necessary for climate policy effectiveness. From a macroeconomic perspective, the greater the synchronization of business cycles, the greater the potential for policy coordination and joint decision making. In light of the procyclical behaviour between the business cycle and the carbon emission cycle, this work tries to shed light on carbon emission fluctuations of sixteen major developed and developing economies during 1946–2021. In analogy with “classical” business cycle research, the analysis dates expansionary and contractionary phases, determines their durations and amplitudes. It also inspects emission synchronization between pairs and groups of countries in order to assess their degree of carbon integration. Carbon emission fluctuations are mostly an expansionary phenomenon. Compared to developed countries, developing countries feature on average longer cycles (i.e., a lower number of full cycles), less time spent in contraction, longer expansionary phases, shorter contractionary phases and larger absolute amplitudes. Pairwise carbon emission fluctuations are synchronized in 34.2% cases. Developed economies have their own common emission cycle. As for developing economies, results are heterogeneous. Only part of them, in fact, shows evidence of a common carbon emission cycle despite a relatively recent history of cooperation, heterogeneous geographical locations and socio-cultural features.

The impact of IFRS 9 on the cyclicality of loan loss provisions

AbstractThrough their procyclical behavior, loan loss provisions have been determined as one of the factors that contribute to financial instability during a crisis. IFRS 9 was introduced in 2018 with an expected credit loss model replacing the incurred loss model of IAS 39 to mitigate the effect in the future. Our study aims to analyze loan loss provisions of major banks in the Eurozone to determine for the first time if the implementation of IFRS 9, as intended by regulators, has a dampening effect on procyclicality, especially during the stressed situation under COVID‐19. We analyze 51 banks from 12 countries of the European Monetary Union using 2856 firm‐year observations. While no robust evidence of less procyclicality can be found after the implementation of IFRS 9 until the pandemic, we find evidence that loan loss provisions moved countercyclical during 2020, indicating an alleviating effect at the beginning of the exogenous shock.

Islamic bank procyclicality in an emerging market economy: Do bank size and financing contracts matter?

Using a sample of Islamic banks in Indonesia, our empirical findings demonstrate a positive relationship between economic growth and financing growth in Islamic banks, indicating procyclical behavior. However, the degree of procyclicality varies depending on bank size, with small banks exhibiting a more pronounced procyclical behavior compared to large banks, which display a countercyclical pattern. Our deeper analysis reveals that consumption financing contracts through Murabahah and Istisna contribute to the countercyclical behavior observed in large Islamic banks. Moreover, Musharakah as a productive financing contract does not exhibit procyclical behavior regardless of bank size. In contrast, another productive financing contract, Mudharabah, can lead large Islamic banks to behave countercyclically. Additionally, Ijarah, a leasing contract used for either consumption or productive purposes, exhibits a procyclical pattern in large Islamic banks, indicating that it cannot serve as a hedge during economic downturns for these banks. Overall, these results underscore the importance of Islamic bank consolidation, as large Islamic banks tend to effectively overcome procyclicality throughout the business cycle by utilizing the majority of financing contracts.

Labor market flows: Evidence for Chile using microdata from administrative tax records

We compute and characterize several labor flow measures using administrative tax records for all formal Chilean firms and employees. Our results show that labor mobility in Chile is significant by international standards, with the reallocation rate averaging 37% over the last decade, the highest value among the 25 OECD countries with comparable data. The magnitude of labor reallocation is highly heterogeneous among firms and industries, highest in Agriculture and Construction. Job reallocation is also high for smaller companies, primarily due to high firm creation and destruction rates, and for firms that pay lower wages. Finally, there is a significant procyclical behavior of workers’ entry rate and, in smaller magnitude, a countercyclical reaction of the exit rate, consistent with international evidence that shows job creation as the main adjustment mechanism over the business cycle.

Towards a macroprudential regulatory framework for mutual funds?

AbstractThis paper highlights the procyclical and unstable behaviour of mutual funds, characterized by a varying sensitivity on common asset pricing factors. It proposes a novel factor model that allows for regime changes associated with macroeconomic and financial state variables. Estimated on a panel covering 825 US equity mutual funds over a period of 30 years, it appears that the yield curve, the dividend yield, short term interest rates and the industrial production coincide with regimes switches in the Fama–French factors. Furthermore, the estimated regimes coincide with financial crises and economic downturns, thus confirming the procyclical behaviour of mutual funds' returns. These findings, coupled with the emerging systemic role of mutual funds, promote the consideration for a specific macroprudential regulatory framework targeted at the mutual fund industry.

Housing prices and macroprudential policies: Evidence from microdata

This paper examines the efficacy of macroprudential policies in addressing housing prices in a developing country like India, utilizing two novel databases on city-level house prices in India. Though the empirical models provide evidence of a sizable effect of the fundamental factors in influencing house price dynamics, they also reveal strong countercyclical properties of macroprudential tools i.e., loan-to-value (LTV) limit, risk weights, and provisioning requirements, in influencing housing price movements. Among the macroprudential policy tools, the LTV limit emerges as the most potent one in influencing the price dynamics. A granular investigation of the effectiveness of macroprudential tools suggests that the countercyclical effect of the regulatory ratios for large-sized mortgages is much stronger as compared with those for the small-sized mortgages, attributed mainly to investment motives associated with the large-sized loans. We also find the presence of asymmetry in the impact of loosening versus the tightening of the LTV limit, which can be attributed to the procyclical behavior of the house prices.

Regional business cycles in emerging economies: a review of the literature

PurposeThis article offers a review of the literature on regional business cycles (BCs) in emerging economies. The objective is synthesizing the existing studies based on theoretical, empirical and methodological approaches.Design/methodology/approachThe methodological framework includes the following stages: research questions, bibliography location, the selection of articles and the evaluation of the literature, analysis and synthesis, and the reporting and use of results.FindingsThe evidence suggests that expansionary phases last longer than recessions'; public expenditure shows a pro-cyclical behavior; and factors such as productive structure and international trade explain the synchronization of regional BCs.Originality/valueUp until now, there is no research that performs a review of regional BCs in emerging economics.

The Risk-Taking Behaviour of Tunisian Banks in the Post-Revolution Era: A Panel ARDL-PMG Approach

This study investigates the long-term determinants of capital buffers and risk-taking adjustment by focusing on a sample of listed Tunisian commercial banks. This research uses hand-collected semi-annual data. The panel autoregressive distributed lags technique is used to control for unit root processes and to check for long-term determinants of capital and risk-taking adjustment. The empirical findings prove the existence of a moral hazard and procyclical behaviour of Tunisian banks in response to capital requirements. However, some results indicate that capital standards are still an important prudential tool for ensuring the robustness of Tunisian banks. There have been no previous studies focusing on this issue in the context of the Tunisian banking system in the turbulent post-revolution era. This paper innovates by assuming that a set of bank-specific, macroeconomic and regulatory variables exert a long-term rather than a short-term influence on capital buffers and risk-taking. The research does not consider a possible long-term simultaneous relationship between capital and risk-taking. The sample could be extended if data were available. Tunisian banks are advised to diversify their sources of revenues and to thoroughly revise their business models in order to become less dependent on revenues from traditional intermediation activities and to reduce the procyclicality of the banking system.

Asymmetric impact of capital controls on international trade

Capital control policies have asymmetric effects on international trade. This study uses quarterly data on 25 emerging countries from 2011 to 2019. Our empirical approach performs long- and short-standing capital controls dynamic panel models, and applies different robust estimations techniques. We find evidence that capital controls mitigate the adverse effect of the exchange rate, interest rate differential, and inflation volatilities. The long-lasting capital controls « walls » are more effective than short-lasting capital control « gates». Besides, the effects of these controls are asymmetric according to their procyclical behavior and the financial development level. Capital controls impact on international trade raises two major policy implications. Targeting long-lasting controls is more useful than targeting episodic controls, and policy coordination between exchange rate, monetary, and restrictive policies is necessary to support international trade.

MEASURES OF FINANCIAL REGULATORS IN THE FIELD OF INTERNATIONAL CAPITAL FLOWS CONTROL

The article attempts to identify new trends in approaches to assessing the impact of uncontrolled international capital flows on the development of the national economy and the corresponding changes in regulatory policies. It is pointed out that uncontrolled capital flows pose a special threat to small open economies due to insufficient development of the institutional environment and low depth of financial markets. There has been constructed circle of typical for small open economies risks, conducted with uncontrolled capital flows movement, such as deepening structural imbalances in financial asset markets, undesirable excessive fluctuations in the national currency rate, the flight of national capital and the erosion of the tax base. Based on the analysis of recent research, international regulatory initiatives of EU countries, recommendations of international development institutions and IMF’s Integrated Policy Framework, have been identified such trends as strengthening control over illegal capital flows, limiting of the negative speculative influence, panic and herd behaviour on exchange rate stability. Argued for a very important role which plays an uncontrolled dynamics of national currency rate on the transmission of global shocks to national economies. This necessitates a serious overhaul of exchange rate policy approaches. Central banks of small open economies should consider exchange rate stability as one of their goals. This does not mean inflation targeting abandon. The use of the instrument of currency interventions helps to influence the achievement of external targets, increasing the ability of interest rate policy instruments to achieve inflation targeting in the domestic market as well. As a conclusion and proposals for further development of policies in the financial sector to ensure the sustainable development of small open economies is systematized a list of possible regulatory measures. It is emphasized that the development of regulatory policies in the monetary and financial spheres in small open economies, which includes Ukraine, should be implemented comprehensively and include the development of macroprudential tools to limit systemic risk factors, suppress illicit capital flows and reduce the role of psychological factors of pro-cyclical behavior. The implementation of regulatory measures on transparent terms in such spheres will not make free-market self-regulatory mechanisms weaken, but rather helps to release them.

Are defined contribution (DC) pension funds a stabilising factor in equity markets? Evidence from Chile, Italy, Mexico and Poland

We analyse the investment behaviour of the defined contribution (DC) pension fund sector in equity markets during and after the 2008–2009 financial crisis until the years 2014–2016 and here for Chile, Mexico, Poland, and Italy. We employ quarterly data on equity purchases and sales and on cash flow at the level of the whole pension sector. Applied are the following methods: analysis of average quarterly transactions; scatter plot analysis of the relation between average quarterly net purchases and quarterly changes in asset value, a correlation analysis of average quarterly transactions in the equity market and its index values, regression analysis of average quarterly transactions in the equity market and its index values. The results indicate that in Poland and Italy, pension funds behaved counter-cyclically, whereas in Chile there are some signs, although less statistically significant, of pro-cyclical behaviour. In the case of Mexico no conclusions could be drawn. The investment behaviour of pension funds might be influenced not only by their strategic decisions but also by other factors that are related to the institutional framework they operate within (e.g. a strategic asset allocation benchmark may induce pro-cyclicality).

Business cycle and mortality in Spain

In the last couple of decades, there has been a lot of interest on the impact of macroeconomic fluctuations on health and mortality rates. Many studies, for different countries, find that mortality is procyclical. However, studies examining the effects of more recent recessions are less conclusive, finding mortality to be less procyclical, or even countercyclical. In this paper, using data of Spanish provinces from 1999 to 2016, we investigate how this relationship works in the context of a country that is subject to extreme business cycle fluctuations. Furthermore, we analyze the impact of unemployment for different mortality causes and we explore differences by sex, age group and level of education. In general terms, we find mortality to be procyclical so that when the economy is in a recession, mortality falls. When exploring mortality causes, we show that deaths from cardiovascular disease, cancer, senility, transport accidents and homicides are procyclical. By sex, we find procyclicality for both men and women. By age, mortality is procyclical for all age groups; however, the causes of death that result in this procyclical behavior are specific to each age group. By educational level, suicide appears as a countercyclical cause for individuals with intermediate levels of education.

Procyclical asset management and bond risk premia

We use unique institutional securities holdings data to examine the trading behaviour of delegated institutional capital and its impact on bond risk premia. We show that institutional fund managers trade strongly procyclically: they actively move into higher yielding, longer duration and lower rated securities as yields fall and spreads compress, and vice versa. Funds more exposed to negative yields increase their risk-taking more strongly, and this effect is particularly pronounced for those offering explicit minimum return guarantees. Institutional funds' investments have large and persistent price impact in both corporate and sovereign bond markets. We provide evidence that this procyclical behaviour is driven by career concerns among institutional fund managers.

The pro-cyclicality of risk weights for credit exposures: Driven by the retail segment

This paper examines the pro-cyclicality of implicit risk weights of credit exposures and the potential contribution of accommodative monetary policy using data for the Czech Republic. The empirical results indicate that risk weights behave pro-cyclically under the IRB approach and acyclically under the STA approach. The pro-cyclical behaviour of IRB risk weights is caused primarily by the retail exposures, the strongest effects being in the highest and lowest quantiles of risk weights. The risk weights for retail exposures behave pro-cyclically not only with regard to the business cycle, but also with respect to the financial cycle and house price growth. In addition, monetary policy easing contributes to the pro-cyclicality in higher quantiles of risk weights.

Cyclical drivers of fiscal policy in sub-Saharan Africa: New insights from the time-varying heterogeneity approach

We extend the topical literature on the cyclical behavior of fiscal policy in developing countries subject to terms of trade cycles by applying the interactive fixed effects model that allow for unobserved time-varying heterogeneity in the impact of fundamentals. Based on a sample of 20 sub-Saharan African (SSA) countries from 1985 to 2017, our results support existing evidence about developing countries that fiscal policy is pro-cyclical in SSA countries. Whereas this pro-cyclicality is valid for government spending and fiscal balance, government revenue is slightly counter-cyclical. We also find that the pro-cyclicality of government expenditure and fiscal balance escalates during episodes of terms of trade booms. Our results make a strong case for the support of the pivotal role of Sovereign Wealth Funds, access to international financial markets, and flexible exchange rate regimes in reversing the pro-cyclical behavior of fiscal policy.

Procyclical Asset Management and Bond Risk Premia

We use unique institutional securities holdings data to examine the trading behaviour of delegated institutional capital and its impact on bond risk premia. We show that institutional fund managers trade strongly procyclically: they actively move into higher yielding, longer duration and lower rated securities as yields fall and spreads compress, and vice versa. Funds more exposed to negative yields increase their risk-taking more strongly, and this effect is particularly pronounced for those offering explicit minimum return guarantees. Institutional funds' investments have large and persistent price impact in both corporate and sovereign bond markets. We provide evidence that this procyclical behaviour is driven by career concerns among institutional fund managers. JEL Classification: G11, G23, E43

Procyclical Effects of IFRS 9 – Illustrated by a Simulation on the Hungarian Banking System

The impact of the IFRS1 9 accounting standard on amplifying procyclical bank behaviour has been hotly debated since the introduction of the standard. This paper contributes to the debate by a unique simulation, in which we estimated, what the losses and capital position of the Hungarian banking system would have been during the 2008–2013 crisis episode if at international level subsequently adopted IFRS 9 had already been in effect at that time. Our results show that IFRS 9 would have led to the recognition of losses, which would have been more concentrated in the beginning of this crisis episode, (but not early enough, in the pre-crisis period). As a result, the banking system’s aggregated capital adequacy ratio would have been more than 20 per cent (2.7 percentage points) lower at the onset of the crisis (end of 2008) than it was in reality (9.1 per cent rather than 11.8 per cent). This could have forced bank owners to undertake capital increases sooner and in larger amounts or to push their banks towards even stronger deleveraging, i.e. towards more procyclical behaviour. Our results are in line with the findings in the literature that the introduction of IFRS 9 increases the procyclicality of banks’ impairments in such a manner that it shifts the recognition of impairments towards beginning of crises (but not towards pre-crisis periods!). Although the procyclical effect of IFRS 9 demonstrated in our simulation is quite large, this is attributable to the special depth and complexity of the 2008 crisis episode in Hungary, which involved a sovereign crisis, a banking crisis and a credit crunch at the same time. Thus, our results suggest that the procyclical impact of IFRS 9 can be more easily managed under ‘normal’ recession circumstances