Short and medium term financial-real cycles: An empirical assessment

Theories such as Minsky’s financial instability hypothesis or New Keynesian financial accelerator models assign a key role to financial factors in business cycle dynamics. We propose a simple VAR-based estimation framework to examine some of the financial-real interaction mechanisms that are at the core of these theories. We examine cycle frequencies in seven OECD countries over the period 1970–2015, and find that output contains short- and medium business cycle frequencies, while interest rates, business debt, and household debt exhibit short-, medium- and long cycles, respectively. We find robust evidence for financial-real interaction mechanisms (i) at high frequencies between interest rates and GDP in Australia and the USA and (ii) at medium frequencies between business debt and GDP in Canada and Great Britain. The effect of interest rates and debt seems to operate via investment rather than consumption. We find no evidence for an interaction mechanism between household debt and GDP. Our results provide support for Minskyan and financial accelerator models in which output interacts with interest rates or corporate debt.