The financial and the real cycle: a theoretical approach and a case study

Abstract

This dissertation touches upon two themes. It discusses the existence of the financial cycle and its relationship to the real cycle (better known as the business cycle). It does so, first, by presenting some of the existing literature and research on the topic. Secondly, it introduces a “lightweight” analytical model that generates financial fluctuations based on the behaviour of the economic agents whilst being unaffected by the real economy. Finally, it searches for it empirically in macroeconomic data for the USA and confirms it as a standalone phenomenon,independent of the real cycle, via a causality test. The second theme analyzed here is macroprudential policy. Macroprudential policy is a proposed type of policy(independent of fiscal and monetary policy) which aims to preserve financial stability in an economy. In particular, this dissertation covers a wide range of topics concerning it but mostly focuses on the attitude it should have against systemically important financial institutions and provides with statistical evidence that uncontrollable bailing-out of systemic banks is directly detrimental to social welfare and indirectly inhibits competitiveness in financial markets.