Dynamic lag structure of deposits and loans interest rates and business cycles formation
| Date | 08 May 2017 |
| Pages | 114-132 |
| Published date | 08 May 2017 |
| DOI | https://doi.org/10.1108/JFRC-09-2016-0078 |
| Author | Bijan Bidabad,Abul Hassan |
| Subject Matter | Accounting & Finance,Financial risk/company failure,Financial compliance/regulation |
Dynamic lag structure of deposits
and loans interest rates and
business cycles formation
Bijan Bidabad
Research Department, Bank Melli Iran, Tehran, Iran, and
Abul Hassan
Department of Finance and Economics,
Centre for Research Excellence of Islamic Banking and Finance,
King Fahd University of Petroleum and Minerals, Dhahran, Saudi Arabia
Abstract
Purpose –This paper aims to study the structural dynamic behaviour of the depositors, banks and
investors and the role of banks in the business cycles. The authors test the hypothesis: do banks’ behaviour
make oscillations in the economy via interest rate?
Design/methodology/approach –The authors dichotomized banking activities into two markets:
deposit and loan. The rst market forms deposit interest rate, and the second market forms credit interest rate.
The authors show that these two types of interest rates have non-synchronized structures, and that is why
money sector uctuation starts. As a result, the uctuation is transferred to the real economy through saving
and investment functions.
Findings –The empirical results show that in the USA, the banking system creates uctuations in money
and real economy, as well as through interest rates. Short-term interest rates had complex roots in their
characteristic, while medium and long-term interest rates, though they were second-order difference
equations, had real characteristic roots. However, short-term interest rates are the source of oscillation and
form the business cycles.
Research limitations/implications –The authors tested the hypothesis for USA economy, while it
needs to be tested for other economies as well.
Practical implications –The results show that though the source of uctuations in the real economy
comes from short-term interest rates, medium- and long-term interest rates dampen real economy uctuations
and also work as economic stabilisers.
Originality/value –Regarding the applied method, the topic is new.
Keywords Business cycle, Banking sector, Macroeconomics, Interest rate, Banking crisis,
Lag structure
Paper type Research paper
Introduction
Many countries have experienced business cycles in the economy with a sinusoidal trend.
These uctuations spread in other countries because of international transactions of goods
and ow of capital. As a result, the price signals of commodities and various capital yields
create the global ow and therefore the movement of business cycles. Various business
cycles happen weekly, monthly or seasonal, which are caused by inventory uctuations and
last less than half a decade. These cycles are called “Kitchin” cycles, (Kitchin, 1923).
However, it is not a signicant point of discussion of this paper. The main focus of this paper
JEL classication – E32, E43, G01
The current issue and full text archive of this journal is available on Emerald Insight at:
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JFRC
25,2
114
Journalof Financial Regulation
andCompliance
Vol.25 No. 2, 2017
pp.114-132
©Emerald Publishing Limited
1358-1988
DOI 10.1108/JFRC-09-2016-0078
is the uctuations in the economic or business cycles which take place in a decade and turn
the economy from prosperity to recession or crisis, and usually, it takes another decade to
recover the economy. The large cycles, which were caused by structural changes, are known
as “Kuznets” cycles, (Kuznets, 1930). The longer uctuations caused by science and
technological developments that take about half a century to complete are called
“Kondratieff” cycles (Kondratieff and Stolper, 1935). Sometimes, the overlapping of these
cycles with normal business cycles creates deep global crises such as the crises held during
1929 and 2008.
Behaviourally, this instability is due to man’s nature to spend cheerfully. The rich people
spend more extravagantly, but the limited available resources do not let them to continue
overconsumption. Therefore, it needs to stop during the economic prosperity. That is
because resources do not increase proportionally to people’s economic activities. The
scarcities of resources cause price increase and a decrease of prot margin, which is the
beginning of the recession and the turning point of the business cycle. This reasoning is
actually originating from the human nature; however, the inconsistent termed structure of
loans and deposits force the banks (as an intermediary between monetary resources and real
sector activities) to experience different losses and prots at different times. In this paper, we
will show that the time structure of loan and deposit creates liability of nancial loads to
banks and forms monetary oscillation. In the following stage, monetary oscillation affects
the real economy. Our methodology in this paper is to dichotomize banking activities into
two markets:
(1) saving supply and bank’s deposit demand market; and
(2) investment demand and bank’s credit supply.
The rst market forms deposit interest rate and second market forms credit interest rate. In
an analysis of these two rates, we will show that if these two types of interest rates were
time-inconsistent, then monetary uctuation starts. As a result, the uctuation is transmitted
to the real sector through saving and investment functions. Empirically, this study will test
the hypothesis through estimating the characteristic roots of difference equations, which will
be derived from the theoretical analysis using ten different interest rates of USA.
Business cycle theories
This phenomenon was realised for the rst time by Juglar (1862) for spans of 8-11 years.
Later, several theories were introduced about business cycles, which studied business
cycles from different points of view. Schumpeter (1954) described the four stages of the
business cycle. The rst stage of prosperity wherein there is an increase in production
and prices and a decrease in the interest rate. During the second stage of the recession
where the production and prices decrease, the interest rate increases until the economy
reaches the third stage of crisis due to collapse in the stock market and bankruptcy. The
recovery begins during the fourth stage, which is accompanied by stock market’s
prosperity and the increase in output, demand and prices.
Goodwin (1949,1991) believed that the reason for business cycles was the gap
between income distribution between the prot of investors of economic rms and the
earnings of the labour force. When the economy has a high employment rate, the labour
demand increases but the workers cannot ask for higher wages as the employment
contracts are annual or have xed periods, and therefore, the wages can only be changed
after the end of the duration of the contract. But, the reverse happens during recession.
Therefore, the income of the labour force is adjusted with the income of capital factor
after a time lag, which creates a cyclical behaviour for matching production with
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Dynamic lag
structure
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