Business and Financial Cycles: an estimation of cycles’ length focusing on Macroprudential Policy

Business and financial cycles are important to Monetary and Macroprudential Policies. The Countercyclical Capital Buffer (CCB) proposed by the Basel Committee on Banking Supervision (BCBS) assumes that the financial cycle is four times longer than the business one with direct impacts over its main indicator, the credit-to-GDP gap. This paper addresses the issue of estimating credit and business cycles’ length using Bayesian Structural Time Series Models (STM) and Singular Spectrum Analysis (SSA) followed by Fourier-based Spectral Analysis. The results, considering 28 countries, suggest that financial cycles, measured by the credit-to-GDP, could indeed be longer than the business one, but definitely shorter than the one implied in the cut-off frequency used by the BCBS. We find that most countries in the sample have financial cycles between 13 and 20 years, but there is a smaller group of countries whose estimates are close to those of the business cycle, i.e., 3 to 7 years. Finally, we estimate q-ratios objectively using STM and find that a HP smoothing factor that closely relates to the gain functions of our estimated state space form is in the trend component of HP(150) and not in the gap of HP(400k).