Financial and Real Business Cycles

Abstract

An empirical analysis of the business cycle that demonstrates the nature and characteristics of both financial and real business fluctuations in the US economy during the 1980s is provided. It is argued that the business cycle is fundamentally financial in nature, with identifiable financial business cycles occurring simultaneously with real business cycles, both through direct cause and effect and interactions with the real phenomena traditionally identified as the major sources of a changing economy. A large-scale structural macroeconometric model, the Sinai-Boston Model of the US Economy, is used to demonstrate the presence of financial cycles from 1980 to 1990. Financial and real flows exhibit frequent fluctuations of significant amplitude, show definitive effects and interactions with one another in response to shocks, replicate closely the historical track of growth, employment and inflation, and respond to other signals in the system. The overwhelming verdict of history is that both real and financial factors matter for growth, employment, inflation, interest rates and other financial market prices, financial flows, debt, and sectoral balance sheet behavior.

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