Financial cycles: Characterisation and real-time measurement

We demonstrate that financial cycles (identified as the common fluctuation in credit and asset prices, proxying balance-sheet leverage) differ across G-7 countries in terms of duration. This contradicts a similar-duration assumption inherent in the Basel III credit-to-GDP gap guiding countercyclical capital buffers. Against this backdrop, we propose an empirical methodology for constructing country-specific financial cycles that relaxes the similar-duration assumption and is based on the common fluctuation of several variables. Using credit and asset prices as inputs to our methodology, we show that constructed financial cycles significantly outperform the Basel III credit-to-GDP gap in predicting financial crises.