The Impact of Risk Cycles on Business Cycles: A Historical View
47 Pages Posted: 16 Oct 2020 Last revised: 29 Dec 2021
Date Written: December 23, 2021
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-for-long risk environment persists and credit growth is excessive. Global-risk cycles have a stronger effect on growth than local-risk cycles amid their notable impact on capital flows, investment, and debt-issuer quality.
Keywords: Stock market volatility, uncertainty, Minsky’s hypothesis, financial instability, risk-taking, granular instruments (GIV), global financial cycles
JEL Classification: F30, F44, G15, G18, N10, N20
Suggested Citation: Suggested Citation