Curbing the Credit Cycle

TLDR

Credit cycles, a long‑standing feature of advanced economies, are marked by sustained rises in credit‑to‑GDP ratios that correlate with banking crises and by boom phases with large deviations from trend. The study proposes that macro‑prudential policy can curb credit cycles by raising the cost of risky portfolios and influencing banks' expectations of peers. Credit‑cycle effects arise from mechanisms featuring strategic complementarity among banks.

Abstract

Credit cycles have been a characteristic of advanced economies for over 100 years. On average, a sustained pick‐up in the ratio of credit to GDP has been highly correlated with banking crises. The boom phases of the cycle are characterised by large deviations in credit from trend. A range of mechanisms can generate these effects, each of which has strategic complementarity between banks at its core. Macro‐prudential policy could curb these credit cycles, both through raising the cost of maintaining risky portfolios and through an expectations channel that operates via banks' perceptions of other banks' actions.