The global financial cycle

Dr Justin Pyvis Dr Justin's picture

In a recent NBER working paper by Òscar Jordà, Moritz Schularick, Alan M. Taylor and Felix Ward, Global financial cycles and risk premiums, the authors conclude that:

"First, the comovement in total loans, house prices, and equity prices has reached historical highs over the past few decades... Second, the post-1980 increase in equity price comovement is particularly notable, because it has reached historically unprecedented levels and substantially exceeds the increase in the comovement in other real or financial variables. Third, the post-1980 synchronization of equity prices cannot be easily accounted for by the behavior of dividends or risk-free rates, but instead must be attributed to other factors."

The authors attribute the cause of this new, global financial cycle to central banks in major economies, which they dub "center countries", given the influence they now have on global financial conditions. Equities appear to have been the most affected asset class and are now at an historical peak of 0.8 (with a correlation coefficient of 1 being perfect), which makes sense given that they are very liquid and less susceptible to factors which might reduce comovement, such as localised supply constraints in housing markets.

equity-price-correlation-june-2018.png#asset:7469

The global financial cycle means that the world's business cycle - in particular, the developed world's - now essentially moves in unison. The next crisis in the United States will spread to other economies, even more-so than did the 2007 'global' financial crisis.