Monetary Cycles, Financial Cycles and the Business Cycle

19 Pages Posted: 6 Jan 2010  

Tobias Adrian

International Monetary Fund

Arturo Estrella

Rensselaer Polytechnic Institute

Hyun Song Shin

Bank for International Settlements

Date Written: January 1, 2010

Abstract

One of the most robust stylized facts in macroeconomics is the forecasting power of the term spread for future real activity. The economic rationale for this forecasting power usually appeals to expectations of future interest rates, which affect the slope of the term structure. In this paper, we propose a possible causal mechanism for the forecasting power of the term spread, deriving from the balance sheet management of financial intermediaries. When monetary tightening is associated with a flattening of the term spread, it reduces net interest margin, which in turn makes lending less profitable, leading to a contraction in the supply of credit. We provide empirical support for this hypothesis, thereby linking monetary cycles, financial cycles, and the business cycle.

Keywords: monetary policy, financial intermediation

JEL Classification: E52, E50, E44, G18

Suggested Citation

Adrian, Tobias and Estrella, Arturo and Shin, Hyun Song, Monetary Cycles, Financial Cycles and the Business Cycle (January 1, 2010). FRB of New York Staff Report No. 421. Available at SSRN: https://ssrn.com/abstract=1532309 or http://dx.doi.org/10.2139/ssrn.1532309

Tobias Adrian (Contact Author)

International Monetary Fund ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

HOME PAGE: http://www.tobiasadrian.com

Arturo Estrella

Rensselaer Polytechnic Institute ( email )

110 8th Street
Troy, NY 12180
United States

Hyun Song Shin

Bank for International Settlements ( email )

Centralbahnplatz 2
Basel, Basel-Stadt 4002
Switzerland

HOME PAGE: http://www.bis.org/author/hyun_song_shin.htm

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