Financial markets have a major influence on business cycle fluctuations in the real economy

Financial factors have a considerable impact on business cycle fluctuations in Finland s real economy. The financial markets affect the real economy particularly via investments, as the cost and availability of finance significantly influence the level of investment. This article presents the results of a study conducted at the Bank of Finland that indicates the operation in the Finnish economy of a financial accelerator mechanism, under which the cost of external finance required for investment depends on the strength of the borrower s balance sheet. The study also shows that unexpected changes in borrowers financing costs (ie financial market shocks) explain a large proportion of the fluctuations in investment and hence in total output in Finland over the years 1995 2008.