Private sector balance, financial markets, and U.S. cycle: A SVAR analysis

Purpose – Considering the sectoral balance approach of Godley, and focusing only on the two main components of the private sector balance for the U.S. economy (household and non-financial corporate balance), we investigate the relationship between these two sectors, the financial variables, and economic cycle. In particular, we consider all these relationships endogenously. Design/methodology/approach – We estimate a structural VAR model between household and (non-financial) corporate financial balances, financial markets, and economic cycle and we perform an impulse response analysis. All the variables are expressed as cyclical components applying the Hodrick-Prescott filter. Findings - The main result is that: (1) household and corporate balances react to financial markets in the way we expected and discussed; (2) the economic cycle influences the two financial balances; (3) the corporate balance has a positive impact on the cycle; (4) the economic cycle and financial balances influence the financial variables. In particular, point (3) shows that the corporate balance is a leading component of the cycle as suggested by Casadio and Paradiso (2009) and accords with Minsky’s theory of financial instability. Research limitations/implications – The analysis does not include the foreign sector (current-account balance). Originality/value – Our contribution is an important step forward with respect to the two main contributions in literature which use this approach: the Levy Institute macroeconomic team and Goldman Sachs. Methodologically their models are based on some assumptions (such as exogeneity or market clearing price mechanism for the financial markets) which we overcome considering all the relationships studied in an endogenous manner.