**5. The financial cycle**

Within the literature, the financial cycle proxies are with several definitions such as the house-pricing asset, the interest rate, the stock market, and the exchange rate. The literature review opts for several approaches to measure the financial cycle within the connectedness with the business cycle. Drehmann et al. [14] propose two approaches to measure the financial cycle such as the turning point analysis and the Band-Pass filter using five financial variables such as the credit, the credit to GDP ratio, property price, equity price, and an aggregate asset price index, the study distinguishes a short term financial cycle and a medium-term financial cycle. Borio [8] recommended the use of credit and property price as the interlink between credit and saving and investment to measure the volatility and the cyclicity of the financial cycle.

Gorton and He [62] used real estate as collateral for credit and property price fluctuations affecting the credit and induce pro-cyclicality of credit and real estate price. The credit to GDP is considered as leverage measure in the macroeconomic context and an indirect indicator of the absorptive capacity of the financial system [63]. Regarding the stock market price, there is a controversial debate about a measure for the financial cycle. Drehmann et al. [14] argued that share prices do not fit as a proxy component of the financial cycle because they exhibit comparatively higher volatility at short-term frequencies and co-move far less with the other series. However, Schüler et al. [64] find that share price creates important common cyclicality with credit and residential price, while Tölö et al. [65] claimed that stock returns are considered as an early indicator warning of crisis.

In the same perspective of a combined measure Drehmann et al. [14], and Stremmel [17], use various financial measures such as the credit-to-GDP ratio, credit growth, and the ratio of house price to income. Drehmann et al. [14], Stremmel [17], Aglietta and Brand [66], Merler [67], Galati et al. [68], Schüler et al. [20] stress that despite there is no consensus on the best measure of the financial cycle that a composite financial cycle exploiting the co-movement of credit growth and house price is the best indicator of the systemic banking crisis.

The main goal of this chapter is to investigate the interconnectedness of the financial cycle and the global business cycle and not to provide a more developed measure of the financial cycle. Therefore, we opt on the chapter for using one indicator and not the

*The Global Business Cycle within the New Commodities and the Financial Cycle… DOI: http://dx.doi.org/10.5772/intechopen.111482*

#### **Figure 3.**

*The cycle of each global asset apart obtained by band-pass filter. Source: Own study.*

composite variables such as the asset price indicator of three global assets such as the MSCI, S&P, and the FTSE. To measure the financial cycle, we construct an index of the combined three global assets based on the variable proposed by the literature such as the aggregate asset price index, all the series are normalized to Q1 1984, and in logs. As a first step, we use the filter band pass to filter the data and remove the low-frequency movement. We build the combined index of the financial cycle indicator by taking the average of the three filtered time series of the weighted stock prices. **Figure 3** plots the cycle of each global asset apart obtained by the Band-Pass filter.

The blue line in **Figure 3** shows the FTSE world cycle, the green line shows the S&P world cycle, and the red dotted line shows the MSCI world cycle. For the MSCI and the FTSE, they follow the same trend with the same peaks, we can discern 4 peaks in 1990, 2000, 2008, and 2015 implying a peak-to-peak average cycle of 5 years. After the Asiatic and the Russian crisis, there are three peaks, 2000, 2008, and 2015, implying two cycles of 8 years from peak to peak. Regarding the S&P, they keep the same trend as the MSCI and FTSE with a lag of two years. There are short periods of cyclical movement within these cycles. **Figure 4** shows the financial cycle for the global stock market based on the selection of three global assets with a Band Pass filter.

**Figure 3** shows the financial cycle for the global economy based on the variable of the aggregate stock market returns for the main global asset. Based on that filtering approach we have four upswings, 1990, 2000, 2007, and 2014, and four downswings, 1991, 2003, 2009, 2016. The dipper downswing is in 2009, corresponding to the subprime crisis, as it is the biggest crash for the stock market compared to the other financial crisis.
