Since the mid-1980s economic downturns have typically been preceded by financial booms rather than marked monetary tightening to quell inflation and the state of the financial cycle rather than a flatter yield curve has done a better job in signaling recession risks, according to the Bank for International Settlements (BIS).
In the latest quarterly review of international banking and financial markets, BIS economists find that the nature of recessions has changed since 1985 when compared with the period from 1970 to 1984, with inflation now lower, short-term interest rates only rising modestly and the term spread narrowing far less than before.
In contrast, expansions of the financial cycle has been very much in evidence ahead of recessions in the last 30 plus years, leading the authors to conclude there has been a shift from inflation-induced recessions to financial cycle-induced recessions.
Since the mid-1980s the global economy has changed dramatically. Financial markets have been liberalized, central banks have been squarely focused on curbing inflation and the entry of China and former Communist countries into the global economy has boosted supply and competitive pressures.
Following the Global Financial Crises, BIS put a spotlight on the nature of the financial cycle, which moves in 15-20 year spans rather than the business cycle that can last up to 8 years.
The article, "The financial cycle and recession risk" is authored by Claudio Borio, head of BIS' Monetary and Economic Department, and Mathias Drehmann and Dora Xia of BIS.
Click here to read the BIS Quarterly Review.
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