Macrofinancial History and the New Business Cycle Facts Discussion - PowerPoint PPT Presentation

Macrofinancial History and the New Business Cycle Facts Discussion by: Marco E. Terrones Worshop on Estimating and Interpreting Financial Cycles. The views expressed in this discussion are those of the author and do not necessarily represent those of the IMF or IMF policy. Marco E. Terrones Macrofinancial History Sep 2016 1 / 15

Questions and Main Findings Q1: What phenomenon has the advanced economies (AEs) experienced over the past 50 years? ◮ The AEs have experienced the so-called financial hockey stick – private credit (particularly mortgages) has reached record levels. Q2: Has the financial hockey stick been associated with changes in the cyclical characteristics of these economies? ◮ Duration and amplitude. Expansions associated with rapid credit growth are stronger and more durable. Yet, the recessions that follow are deeper. ◮ Volatility and skewness. High credit is associated with less volatility in real variables; yet, it is also associated with worse tail events and lower growth. ◮ Synchronization. Real (real and financial) variables are more synchronized in high credit economies. ◮ International synchronization. Advanced economies have become both more "financialized" and synchronized. Marco E. Terrones Macrofinancial History Sep 2016 2 / 15

Discussion Very interesting paper on an important and under-researched area. It builds on previous work of the authors. ◮ Introduces a new macrofinancial dataset (17 AEs, 1870-2013). ◮ Corroborates the presence of financial hockey stick in AEs, which signals a shift to a new "credit era" . ◮ Examines the implications of the financial hockey stick for the Business Cycle (BC) and Financial Cycle (FC) of these economies. Very important findings; however, the issues of causality and the drivers of "financialization" need further research. Moreover, the BC and FC should be clearly identified. ◮ The links between BC and FC have been documented by others (i.e. Claessens, Kose, and Terrones (2009, 2012)). ◮ Using various methods to identify cycles and document their moments can be confusing. ◮ While using long time-series has pros, it also has cons. Marco E. Terrones Macrofinancial History Sep 2016 3 / 15

Roadmap The financial hockey stick. What is it? Causality? Triggers? The financial hockey stick and the business cycle characteristics in the AEs. ◮ Are the BC and FC features robust to the methodology utilized to define these cycles? ◮ Pros and cons of using 150 years of annual data. Conclusion Marco E. Terrones Macrofinancial History Sep 2016 4 / 15

The Financial Hockey Stick. What Is It? Stylized fact whereby private credit to GDP in the AEs has risen markedly over the past 50 years (Schularick and Taylor, 2012). Fig. 1. The Financial Hockey Stick (Mean, 1870-2013) (Median, 1870-2013) 140 140 120 120 100 100 Percent of GDP Percent of GDP 80 80 60 60 40 40 20 20 0 0 0 5 0 5 0 5 0 5 0 5 3 0 5 0 5 0 5 0 5 0 5 3 8 7 8 8 9 0 9 1 9 3 9 4 9 6 9 7 9 9 0 0 0 1 8 7 8 8 9 0 9 1 9 3 9 4 9 6 9 7 9 9 0 0 0 1 1 1 1 1 1 1 1 1 1 2 2 1 1 1 1 1 1 1 1 1 2 2 Date Date Credit to GDP Money to GDP Credit to GDP Money to GDP Source: JST, 2016 Private credit to GDP has been used as a proxy for financial development. Marco E. Terrones Macrofinancial History Sep 2016 5 / 15

The Financial Hockey Stick. Causality Development literature: ◮ Fin. development is Fig. 2. Fin. Development and Income correlated with economic activity (Goldsmith (1969)). Does financial development spur income or vice versa? Growth literature: ◮ Fin. development is related to a country’s growth (King and Levine, 1993; Levine, 2005). Does financial development cause growth or vice versa? New literature: ◮ The financialization of the AEs is negatively related to growth and volatility. Which way does causality go? Marco E. Terrones Macrofinancial History Sep 2016 6 / 15

What Factors Could Trigger Strong Credit Expansion? Productivity gains: ◮ Technological progress is typically financed with Fig. 3. Triggers of Credit Booms external sources (i.e. credit). Rapid progress could lead to strong credit expansion. Financial liberalization: ◮ Measures to eliminate financial repression and develop the financial sector have frequently spurred strong credit growth. Financial openness: Mendoza and Terrones (2008, 2012) ◮ A surge in capital inflows often leads to a rapid expansion of credit. Marco E. Terrones Macrofinancial History Sep 2016 7 / 15

Triggers of Credit Booms: Regression Analysis Tab.1. Triggers of Credit Booms. Marco E. Terrones Macrofinancial History Sep 2016 8 / 15

The Blade of the Financial Hockey Stick What factors could have helped form the blade of the financial hockey stick? Globalization and financial sector reforms Fig 4. The Blade of The Financial Hockey Stick (Mean, 1870-2013) (Mean, 1870-2013) 700 140 25 600 120 20 500 100 Financial Reform Index Percent of GDP Percent of GDP 400 15 80 300 60 10 200 40 100 5 20 0 1870 1885 1900 1915 1930 1945 1960 1975 1990 2005 2013 0 0 Date 1870 1885 1900 1915 1930 1945 1960 1975 1990 2005 2013 Date Credit to GDP Trade Openness Financial Openness Credit/GDP Fin.Reform Index Source: MT, 2008, JST, 2016 Indeed, there is a large literature examining how financial globalization might have affected the BC of a country. Marco E. Terrones Macrofinancial History Sep 2016 9 / 15

Methodologies to Identify Business/Financial Cycles Classical. This is a non-parametric method that identifies the turning points using algorithms subject to some censoring rule. Method was pioneered by Bry and Boschan (1971). ◮ Very simple to understand; and ◮ Utilizes the original data; not affected by new incoming data. Detrending. A trend model is fitted to a given series and the cycle is determined as a deviation from this trend. Various detrending models: log-difference; log-linear; log-quadratic; HP filter; band pass filter; etc. ◮ Cyclical component is especific to the detrending method (Canova 1998). ◮ Cyclical component has, in some cases, a unit root or long memory. Marco E. Terrones Macrofinancial History Sep 2016 10 / 15

Business/Financial Cycles Are Method Dependent Fig 5. Real and Credit Cycles in the US Real GDP per capita Real Credit Per Capita (Log level and Trend) (Log level and Trend) 5 5 Index, log Index, log 4 4 3 3 2 2 1 1 1870 1885 1900 1915 1930 1945 1960 1975 1990 2005 2013 1870 1885 1900 1915 1930 1945 1960 1975 1990 2005 2013 Date Date (Cyclical Component) (Cyclical Component) 5 10 15 20 25 5 10 15 20 25 Percent Percent -25-20-15-10 -5 0 -25-20-15-10 -5 0 1870 1885 1900 1915 1930 1945 1960 1975 1990 2005 2013 1870 1885 1900 1915 1930 1945 1960 1975 1990 2005 2013 Date Date Note: Orange=Log level, Grey=HP trend, Red=Growth rate, Blue=HP cycle Marco E. Terrones Macrofinancial History Sep 2016 11 / 15

Cycle Features: Classical vs Detrending Methods Dating of recessions/expansions (downturns/upturns) vary. Cyclical component is sensitive to the detrending model. Confusing to use these methods simultaneously. Fig 6. Detrending Method and Different Smoothing Parameters (US Trend Component) (US Cyclical Component) 3.5 20 3 10 Index, log Percent 2.5 0 -10 2 1.5 -20 1870 1885 1900 1915 1930 1939 1870 1885 1900 1915 1930 1939 Date Date Note: Blue=Lambda 1, Yellow=Lambda 2, Light Blue=Lambda 6.5, Orange=Lambda 100, Red=Log-diff Marco E. Terrones Macrofinancial History Sep 2016 12 / 15

The Financial Hockey Stick and BC and FC Why have the moments of consumption not changed as much to reflect the rapid expansion of mortgages in AEs? ◮ Why has risk sharing not improved significantly? ◮ How does an improvement in household financing lead to changes in the BC characteristics of an economy? Why and how has the financial hockey stick changed the underlying exogenous shocks driving the BC? ◮ Are these effects on the mean or variance or both? ◮ What are the channels? Marco E. Terrones Macrofinancial History Sep 2016 13 / 15

Using 150 Years of Data Has Pros and Cons Pros: ◮ A long history helps study the occurrence of Fig 7. Advanced Economies: Real GDP per Capita rare events –i.e. financial 11 and macroeconomic disasters. 10 Cons: 9 PPP, log ◮ Non-economic 8 convulsive episodes (i.e. WWI and WWII) can 7 change the data generating process. 6 1870 1885 1900 1915 1930 1945 1960 1975 1990 2005 2013 Date ◮ Countries change Note: Red=US, Purple=UK, Magenta=Germany, Yellow=Japan, Blue=Rest substantially in 150 years. Marco E. Terrones Macrofinancial History Sep 2016 14 / 15

Conclusion Interesting paper based on a new macrofinancial database (17 advanced economies, 1879-2013). The advanced economies have experienced the financial hockey stick. But, what explains this development? The financial hockey stick is associated with changes in the business cycle . . . ◮ Lower growth, less volatility, but more negative skewness. ◮ More synchronized real variables with credit. ◮ More synchronized economies. To fully embrace these findings– the issues of causality and the relationship between financialization, financial globalization and financial sector reform need to be settled. Marco E. Terrones Macrofinancial History Sep 2016 15 / 15