The financial cycle and the regulatory pendulum in the United Kingdom (1885-2016)

The goal of this paper is twofold. First, we study whether there is evidence for a financial cycle, characterized by the joint movement of stock markets and credit aggregates in the United Kingdom from 1885 until 2016. Secondly, after controlling for an assortment of variables, we contrast if the causal relationship between stock markets and credit aggregates, is contingent on the level of financial repression or liberalisation. Regarding the first question, we find evidence of a time-varying relationship between stock markets and credit, and between both variables and the general economy throughout the period. Regarding the second question, our tests show a robust causal relationship between stocks and credit both in the short and long-run. Moreover, said relationship is contingent on whether the economy is experiencing a period of financial repression or latitude. Finally, we contribute evidence that changes in the regulation/deregulation dynamic in 1914 and 1971/79 coincide with structural breaks in our VAR model. Under deregulation, the long-run relationship between both variables was of bidirectional causality. Contrarily, during financial repression, the long-run nexus is broken. These results have implications for the understanding of UK historiography and the underlying mechanisms that drive financial instability.