Abstract
In this paper, the financial cycle of Israel’s economy is identified and characterized, and compared with the real economic cycle. The global financial crisis in 2008 reemphasized the need to examine the role of financial variables in the portrayal of the macroeconomic picture. One of the main phenomena indicated in the literature that began to develop accordingly is the financial cycle. This cycle is characterized by cyclical fluctuations shared by the main variables in the economy’s financial sector, and is distinct from the real cycle in that it is longer and more volatile. An analysis of the connection between the financial cycle and the real cycle allows a better understanding of the macroeconomic processes occurring around financial crises, and can assist in policy decisions. The financial cycle for Israel’s economy is found to be shorter than financial cycles in most countries described in a paper by Borio, et al., and is similar in its features to the financial cycle in Germany. Like Germany, the financial cycle in Israel reached a peak at the end of the 1990s. A period of prolonged decline ensued, until 2006, following which an expansion began, which halted around 2012. This cycle is not synchronized with the financial cycle in the US, where an increase was seen from the middle of the 1990s until the beginning of the crisis in 2008. As such, the global crisis in 2008 broke out when the Israeli economy was in an expansionary period the financial cycle, and it is likely that this increase, alongside additional factors, contributed to the global crisis not leading into a prolonged domestic financial crisis but rather just to a short term recession. The research in this paper also indicates that when periods of real and financial recession overlap, the real recession tends to be longer, and that the financial cycle in Israel is longer and more volatile than the real economy’s cycle. These two points are important, as it is likely that there is room to take them into account when formulating monetary policy.
The identification of the financial cycle is based on a paper by Borio, Drehmann and Tsatsaronis (2012), using two methodologies—frequency based analysis and turning point analysis. These methodologies allow an analysis of the cyclical conduct of main variables in the financial sector and the combination of these variables into a single financial cycle. Out of the various variables examined, it was found that total bank credit, housing prices, long term CPI-indexed government bond yields, and the Israeli government bond risk premium are the most appropriate for characterizing the financial cycle in Israel