The relationship between financial cycles and business cycles: Turkey case

Although the relationship between business cycles and the financial sector has come to the fore from time to time in the 20th century, this relationship was not given enough attention until the 2008 global financial crisis. The devastating effects of the crisis revealed the necessity of clarifying the relationship between financial cycles and business cycles. In this study, the relationship between financial cycles and business cycles in Turkey is examined for the period 1987:1-2021:3. The industrial production index is used to represent business cycles, and loans, stock prices, real effective exchange rates and foreign portfolio investments are used to represent financial cycles. In addition, by using these financial variables, an indicator representing financial cycles was created by principal component analysis. The measurement of financial cycles was performed through the turning point analysis, the Hodrick-Prescott filter and the Baxter-King filter, then synchronization between cycles, correlations and causality relationships were examined. Finally, the variation of the relationship between the cycles with respect to time was estimated with the DCC-GARCH model. According to the findings obtained from the analyzes carried out in the study, stock prices and foreign portfolio investments have leading behaviour, loans have lagging, REDK and factor cycles have coincident or leading behavior. According to the results of Granger causality analysis, while all variables used to represent financial cycles Granger-cause business cycles, business cycles only Granger-cause credit-GDP ratio. The results of the DCC-GARCH analysis show that the ability of financial cycles and business cycles to co-move increases in times of crisis. The variable that has the highest co-movement ability with business cycles is foreign portfolio investments. Considering all these results, It is concluded that financial cycles in Turkey precede business cycles and they are the cause of business cycles. Therefore, neglecting the fluctuations in financial cycles has the potential to cause serious real economic costs in the future. This situation needs to be taken into account by policy makers and policy frameworks that take into account financial cycle fluctuations should be established.