The 2008 financial crisis triggered a major rethink in macroeconomics (Drehmann, Borio, &
Tsatsaronis, 2012). Moreover, the crisis led to an intensive debate about the influence of the financial
crisis on broad economies. Dominant pre-crisis paradigms view finance largely as a sideshow to
macroeconomic fluctuations. Also, finance is usually seen effectivelyas a veil. As a first approximation,
this factor can be ignored when seeking to understand business fluctuations (Woodford, 2003).
However, the crisis demonstrated that this presumption is dangerously false. The past several years have
witnessed recessions in all advanced economies and many emerging markets. A common feature of
these recessions is that they are accompanied by various financial disruptions, including severe
contractions in credit and sharp declines in asset prices. Borio, Disyatat, and Juselius (2013) argued that
information about the financial boom and bust should be considered in improving measures of potential
output and output gaps. In addition, recessions associated with financial disruptions are generally
deeper and long lasting (Claessens, Kose, & Terrones, 2012; Jordà, Schularick, & Taylor, 2013).
These developments have led to an intensive debate in the profession about the links between
finance and macroeconomics. The debate on the direction of causality between financial development
and economic growth has long been an ongoing study (King & Levine, 1993a, 1993b; Shen & Lee,
2006). Past studies commonly support the positive view that finance boosts economic growth (Beck,
2014; King & Levine, 1993a, 1993b). However, some researchers find the opposite to be true (Ghartey,
2015; Vazakidis & Adamopoulos, 2010), or, even worse, that finance development reduces economic
growth (Shen & Lee, 2006; Shen, Lee, Chen, & Xie, 2011).
Against this backdrop, studies on interactions between the two sectors have been propelled to the
forefront of research (Caballero, 2010; Woodford, 2010). The current study aims to re-examine this
issue by using a different set of variables, namely, the financial cycle (FC) and the business cycle (BC),
using data from 31 Chinese provinces. In particular, given that our two cycles are discrete numbers, we
study whether boom leads the expansion and bust leads the recession, and vice versa, which is different
from the literature on financial development and economic growth that focuses on the link between the
two continuous variables. By knowing the lead–lag relation between FCs and BCs, governments can
better introduce financial, monetary, and fiscal regimes. Moreover, enterprises can better arrange
investment and business activities, which will help to mostly reduce the negative impact of FCs on BCs
or BCs on FCs. Such arrangements can also help avoid a severe recession caused by a financial crisis.
Studying the interaction between the two cycles using China's provincial
data is important because the
country has become the second largest economy since 2010.
In addition, China's economy currently
affects many countries significantly (Mirza, Narayanan, & Leeuwen, 2014).
Our study first dates the busts and booms of FCs. Economists have been investigating methods of
dating the expansion and recession of BCs for more than 100 years; however, the dating approach of
FCs is still in its infancy. Claessens, Kose, and Terrones (2011) presented the concept of FCs, which are
separately measured by the three circular movements of credit scale, house prices, and equity prices.
They used Bry and Boschan's (1971) approach, which was later extended by Harding and Pagan
Shen et al. (2011) found an inverted U-shaped curve relationship between financial development and economic growth.
Before the turning point, financial development positively affects economics, after which financial development decreases
the economic growth.
For convenience, we define ‘province’as representing provincial areas, including provinces, autonomous districts, and
Refer to the website: http://www.chinanews.com/fortune/2011/02-15/2844193/html
SHEN ET AL.SHEN ET AL.