Which Global Cycle? A Stochastic Factor Selection Approach for Global Macro-Financial Cycles

Abstract

Instead of assuming a certain factor structure, we statistically test for the factor structure driving common global dynamics in macroeconomic and financial data by employing a stochastic factor selection approach. Using a sample of 16 developed countries from 1996Q1 to 2019Q4, we present strong empirical evidence of a global macro-financial cycle and an independent global financial cycle. Moreover, the global macro-financial cycle we estimate is essentially the global business cycle identified in the literature. It captures the common global macroeconomic dynamics and drives a significant share of the comovement in the financial sector. The remaining commonality in financial variables is driven by separate global financial cycles: the global credit cycle and the global capital flow cycle.

Keywords: Global macro-financial cycle, Global financial cycle, Global business cycle, Multilevel dynamic factor model, Bayesian, Model selection

JEL Classification: E44, F44, C52, C32