The impact of risk cycles on business cycles: a historical view
Abstract: We investigate the effects of financial risk cycles on business cycles, using a panel spanning 73 countries since 1900. Agents use a Bayesian learning model to form their beliefs on risk. We construct a proxy of these beliefs and show that perceived low risk encourages risk-taking, augmenting growth at the cost of accumulating financial vulnerabilities, and therefore, a reversal in growth follows. The reversal is particularly pronounced when the low-risk environment persists and credit growth is excessive. Global-risk cycles have a stronger effect on growth than local-risk cycles via their impact on capital flows, investment, and debt-issuer quality.
Keywords: Stock market volatility; Uncertainty; Monetary policy independence; Financial instability; Risk-taking; Global financial cycles;
JEL Classification: F30; F44; G15; G18; N10; N20;
File(s): File format is application/pdf https://www.federalreserve.gov/econres/ifdp/files/ifdp1358.pdf
Provider: Board of Governors of the Federal Reserve System (U.S.)
Part of Series: International Finance Discussion Papers
Publication Date: 2022-09-09