RDP 8803: Do Financial Aggregates Lead Activity?: A Preliminary Analysis 1. Introduction

Changes in the rate of growth of financial aggregates, frequently raise questions about the relationship between financial aggregates and measures of nominal economic activity. Do increases in the growth of financial aggregates portend future rises in economic activity? Or are the aggregates simply reflecting current or past movements in activity? Is the relationship between money and activity different from that between credit and activity?

This study offers some preliminary evidence on these issues by examining the lead/lag relationship between financial aggregates and measures of real and nominal activity in Australia. Firstly, simple graphical comparisons are used to illustrate lead/lag relationships at turning points. The relationships are then examined using correlation coefficients between current and lagged values of the relevant variables. These tests are generalised further using vector autoregression (VAR) analysis.

The results are not definitive, but on balance they show that financial aggregates tend to move with, but do not lead, activity on both a quarterly and an annual basis. Some of the test results suggest that particular financial aggregates lag activity.

Section 2 briefly describes the links that might be expected between money, credit and activity. Section 3 surveys some of the relevant empirical literature on the question. Empirical results using Australian data are presented in section 4, and section 5 sets out the main conclusions.