Analysis of Business Cycle and Financial Cycle in a Global Perspective with Special Reference to India

Abstract

Pervasive impact of uncertainty necessitates relooking at the traditional empirical approaches to gauge the nexus between the real economy and the financial market, especially after the 2008 financial meltdown. Uncertainty, a disrupter to the investment environment and a discouraging factor to consumer confidence, leads to an eventual fall in output and financial market performance. The recent pandemic and ongoing geo-political tension across the globe further emphasized the need for augmentation of the existing analytical framework to address the prime importance and influence of uncertainty on the real economy and financial market. Therefore, the objective of this research is to analyse the nexus between business cycle and financial cycle against the backdrop of economic policy uncertainty in a global context with special reference to India. newlineTo measure business cycle, this work relies on GDP and index of industrial production (IIP) data whereas, variables related to the stock market, money market and external sector are used to extract the financial cycle using different time-series and frequency based statistical filtering techniques. This thesis used economic policy uncertainty index of Baker, Bloom, and Davis (2016) as a proxy to gauge uncertainty. The major contribution of this work can be attributed to the use of novel methods such as Non-linear ARDL model, Panel-ARDL, DCC-GARCH and TVP-VAR model to investigate the nexus among aforementioned variables using monthly and quarterly data. newlineThe panel ARDL result shows that financial cycle has a positive and significant impact on business cycle in the long-run whereas it has a negative impact on business cycle in short run. The impact of economic policy uncertainty on business cycle is found to be negative and significant in long-run. The result of DCC-GARCH shows that the dynamic conditional correlation between business cycle and financial cycle is positive with temporal variation in India. Empirical findings of TVP-VAR based connectedness method suggest that economic policy uncertainty is the primary transmitter of shocks to the other two variables. In contrast, the business cycle and financial cycle are the primary receivers of shocks for most of the period. Empirical findings of this work have practical policy implications. Findings of this work suggest the need to augment the existing policy framework by incorporating the economic uncertainty component. A stable economic environment is congenial to promote investment and garner consumers confidence to newlinexx newlineboost growth in developing nations like India. Higher policy uncertainty leads to an unstable economic outlook through a disturbed investment environment and consumer confidence. This in turn eventually impacts financial market performance adversely. Hence, the reduction of uncertainty through favourable policy interventions is desirable to promote firm investment and growth in developing nations. Empirical results corroborate that policy uncertainty, the major transmitter of shock, shapes the dynamics of the business cycle and financial cycle in the Indian economy. Owing to the unavailability of data on policy uncertainty, this study is limited to a certain time period. This work also could not explore the nexus of other macro-finance prudential due to data limitations newline