Borio and Beyond

Hat Tip to Tom Hickey for the link to Claudio Borio's Macroeconomics and the financial cycle: Hamlet without the Prince? at VOX. Borio says there is a financial cycle and it differs from the ordinary business cycle, and we cannot understand the economy if the financial cycle is ignored.

It's a great article with lots of insights for policy -- half of them being things I never thought of, to be sure. And you know, if I didn't like the article I wouldn't be talking about it. But I wouldn't be talking about it if I didn't have a different story to tell...


"Since the early 1980s, the financial cycle has re-emerged as a major force," the introductory paragraph says. Re-emerged. "Well-known references" to the financial cycle "go back to at least Lord Overstone (1857)", Borio adds in a footnote.

He presents this graph:

Graph #1: The Business Cycle (red) and Borio's Financial Cycle (blue)

The wiggly red line represents the ordinary business cycle. The wavy blue line represents Borio's financial cycle. You can see, before 1984 or so, that the blue waves of the financial cycle show much less up-and-down variation than the red wiggles of the business cycle. But since 1984, the up-and-down variations of the financial cycle have been much larger. Much stronger.

Beginning in 1984, the graph appears to show one complete "S" pattern (ending around 2003) followed by the first half of a second "S". For Borio, these seem to count as one and a half reps of the financial cycle. For these cycles since the 1980s, he points out, the "typical length is of the order of 16 to 20 years".

But Borio misinterprets the evidence. The large variations of Borio's blue line show a wavelike pattern, but they do not show the financial cycle. That cycle is bigger than Borio's 16 to 20-year waves. Remember Alan Greenspan saying that the financial crisis was the kind of thing that happens once in a hundred years?

Borio's big blue waves together make up the strong phase of a much bigger cycle.

The whole time-period of Borio's large blue waves, beginning around 1984 and lasting, I presume, well beyond the last date of his graph, that whole period is the strong phase of one major financial cycle. The weak phase of that cycle goes back in time from the 1980s to the Depression of the 1930s. This cycle is much longer than 16 to 20 years.

Comparison of the financial cycle to the business cycle is misleading. If we have a few good years of GDP growth, they show up as a bigger wiggle in Borio's red line. That one particular business cycle will stand out from the rest. But when the financial cycle "re-emerges" all the waves are magnified from that point onward, until the financial cycle re-submerges again.

Borio's graph only goes back to around 1970. If you took it back in time, you would see a repeating pattern: large waves for a time, then small waves for a time, then large waves again for a time, and then small waves again: clusters of large and clusters of small repeating, back to the time of Lord Overstone and before. The 16 to 20-year cycle Borio describes is not so much a cycle as it is part of the strong phase of a cycle in which clusters of large (strong) waves and clusters of small (weak) waves alternate in a repeating pattern.

It is the strong phase of this financial cycle that "re-emerged" in the 1980s.


Here is Thomas Philippon's picture of that greater financial cycle, showing great peaks during the Great Depression and again today:

Graph #2, from Has the U.S. Finance Industry Become Less Efficient?
[Missing graph replaced 18 May 2017]

The strong phase since the 1980s appears on this graph as a more rapid increase than we see from the 1940s to 1980. A similar rapid increase appears in the 1920s -- the "Roaring '20s" -- and peaks at the Great Depression. And a third rapid increase comes during the 1890s, and peaks before 1900.

All three of these "rapid increase" periods would show "strong phase" waves, if we had numbers like Borio's to look at. The rapid approach to the peak -- in our time, before the Great Depression, and in the 1890s -- is the time of excessive financialization, the time of excitement in the financial cycle.

By contrast, when financialization is at a minimum, economic growth tends to be strong and the financial cycle shows little excitement.

A time of excessive financialization is a time of excessive debt. Here is my debt-per-dollar graph. Going back only to 1916, it reiterates two of the three peaks Philippon's graph shows:

Graph #3: Total Debt relative to Circulating Money

Here is interest rate data from Robert Shiller. Rates fall during the rapid-increase phase, as financialization rises to a peak:

Graph #4. Source: Robert J. Shiller's Irrational Exuberance

Shiller's interest rate data, going back to 1871, shows three peaks. So does Philippon's. If interest rates typically fall while financialization rises to a peak, then the fall of interest rates from the 1870s to the 1890s must have been accompanied by increasing financialization and increasing debt.

Philippon's graph confirms increasing financialization since 1880, with a peak before 1900.

Finally, here's an old note from Min at Worthwhile Canadian:

The U. S. also had a run-up of private debt before the depression of 1837 - 1843.

That would be four peaks -- including the one Lord Overstone saw.


Borio is right: There is a financial cycle, and it differs from the ordinary business cycle. And we cannot understand the economy if the financial cycle is overlooked.

Related post: "deflation is not necessarily harmful"