Financial cycle in euro area

This section explores the issue of financial cycles in the euro area, taking into account the broader and expanding literature in this area. The measure of the financial cycle explored in this section synthesises information on credit flows and house prices in the Member States and at the aggregate euro area level. When equity is also considered, the amplitude and leading properties of the financial cycle are seen to increase. The synchronisation between domestic financial and business cycles appears relatively strong in all but a few euro area Member States. Financial cycles tend to be somewhat less synchronised across Member States than business cycles, but a fair degree of correlation is still in evidence, especially at the level of individual financial variables. The pre-crisis upswing phase of the euro area financial cycle was preceded by an increase in cross-border debt flows. In the debtor countries, the financial cycle appears to have been at least partly fuelled by debt inflows. The post crisis period saw a slowdown in cross-border debt investment activity, a reversal in previous debt flows and a subsequent downswing in the financial cycle of debtor countries. An econometric analysis of a positive shock to the financial cycle shows that it can boost economic activity and economic sentiment temporally, although at the cost of a medium-term correction and increase in uncertainty. Expansionary phase of the financial cycle may be linked to the build-up of macroeconomic imbalances, which call for a comprehensive and timely approach to macroprudential policy.