Analyzing the synchronization and causality between India’s financial and business cycle: empirical evidence and policy insights

Purpose This research aims to develop an aggregate financial cycle for India and understand its interrelationship with the business cycle. To study this relationship, the research focuses on examining the level of synchronization, comovement and lead–lag relationship between the aggregate financial cycle and the business cycle of India. Design/methodology/approach The study uses principal component analysis and wavelet transform analysis to develop the aggregate financial cycle and understand its time-frequency characteristics, respectively. Then the study undertakes a three-step econometric analysis to measure the various aspects of the relationship between the financial and business cycles. Findings The study found that the aggregate financial cycle and the Indian business cycle have long-term equilibrating relationships. The comovement and the degree of synchronization between the two cycles are moderate, which shows that the relationship between them is relatively dynamic. Further, the lead–lag relationship indicated that the financial cycle often leads the business cycle and not vice versa. Originality/value The research stands out as one of the few works to capture multiple dimensions of the financial market into a single aggregate financial cycle to present a broader picture of an emerging market setting, such as India. This study adds to the literature by systematically investigating the relationship between financial and business cycles over the short-, medium- and long-term horizons.