Relationship between financial distress and phase of the business cycle

Topics: Monetary policy, Economics, Macroeconomics Pages: 2 (955 words) Published: September 9, 2014
Relationship between financial distress and phase of the business cycle

Every time a financial crisis breaks there are many interpretations from economists about the reasons of it and how it is affects output. Is there a relationship between a financial distress and real output? This approach is interesting because allows the compare of impacts of financial variables and financial incidents such as banking crises, stock markets crashes, money supply, interest rates and credit spreads on output. A procession that a researcher could follow according to M. D. Bordo & J. G. Haubrich (2010) is at first identification of timing, duration, amplitude and co-movement of cycles in money, credit and output and then comparison of them by using econometric techniques. After that very important relations between economic variables could be come out. The contribution of economic history is also essential as there are economic policies affecting business cycle (e.g. they could exacerbate or stop a recession).

The USA is a country that there is a lot of data about economic variables. A lot of economists have researched about the causality between financial distress and output. The USA is an example of a country following gold standard. In 19th century the banking system was undeveloped and very unstable so banking panics happened easily. Increases in foreign interest rates could lead to stops in capital inflows, gold outflows and money supply declines. As a result businesses reduce investments and output deteriorates. Also the banking sector was closely related to the stock market and every shock in just one of the two sectors would spread to the other. Mishkin (1990) detected credit crunches as spikes of quality spreads and he also observed asymmetric information problems. Bank did not lend business because their stock market prices had crashed. Those crises were stopped by the suspension of convertibility. After World War I, Fed’s establishment changed monetary policy....

References: Bordo, Michael D. & Haubrich, Joseph G., 2010. "Credit crises, money and contractions: An historical view," Journal of Monetary Economics, Elsevier, vol. 57(1), pages 1-18, January.
Claessens, S., Kose, M.A., Terrones, M.E., 2008. What happens during recessions, crunches and busts?. IMF Working Paper, WP/08/274.
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