Borio JBF (2014)
Borio:

 “…We do not necessarily know more today than we
did yesterday … so-called ‘lessons’ are learnt,
forgotten, re-learnt and forgotten again. Concepts
rise to prominence and fall into oblivion … because
the discipline is not immune to fashions and fads.”
 “The notion of financial booms and busts actually
predates … the more common and influential one of
the business cycle”
The Financial Cycle
Definition

 Self-reinforcing interactions between perceptions of
value & risk [prevailing riskiness of the economy],
attitudes towards risk [risk aversion], & financing
constraints translating into booms followed by busts
amplifying output fluctuations
Thanks Stancho !
Financial Cycle
1st of 5 Stylized Facts

 Variables proxying financial cycle:
 Credit/GDP vs. historical norm (a rough measure of
leverage)
 Property prices vs. historical norm (a rough measure
of steep return to norm)
 Co-vary: credit finances construction & purchase of
housing
 Must focus on small set of variables to replicate the
mutually reinforcing interaction between financing
constraints and perceptions of value & risks
Financial Cycle
nd
2 of 5 Stylized Facts

 Financial cycle has lower frequency than business
cycle (ca. 16 years in industrialized nations)
 Business cycle: 1 – 8 years
Financial Cycle
rd
3 of 5 Stylized Facts

 Financial Cycle Peaks linked to Financial Crises (crises
away from peaks are due to foreign cycles)
Black vertical lines
Show bank crisis
start dates
Financial Cycle
th
4 of 5 Stylized Facts

 Predicts financial distress with good lead time
Levels
Financial Cycle
4B of 5 Stylized Facts

Growth
Rates
 Cross-border credit outgrows domestic credit in finance cycle booms
 Direct: foreign bank loans to domestic non-financial borrowers
 Indirect: foreign loans to domestic banks which lend to domestic non-financial borrowers
Financial Cycle
th
5 of 5 Stylized Facts

 Length & amplitude of financial cycle depends on policy regime
 Financial : liberalization eases financing constraints
 Monetary: inflation targeting regime => low inflation gives BNB no
reason to fight financial cycle boom
 Real-economy : low inflation, credit & asset P booms more frequent
with globalization
Financial cycle longer
& higher amplitude
may be due to
financial deregulation
Borio:
Need New Macro Models

 Financial boom precedes crisis but does it cause it ?
 Include debt and capital stock overhang
 In boom, debt allows increased spending on assets
 In bust, debt forces agents to cut spending
 Rethink concept of potential output (economy at YFE
will stay there absent shocks without inflation)
 But recently output on too-high path while inflation
stable
Borio: How to Modify
Models ??

 Jettison model-consistent (rational) expectations:
agents can’t understand model of economy
 “heterogeneous & fundamentally incomplete
knowledge is a core characteristic of economic
processes”
 Allow risk attitudes to vary with economy’s SON to
naturally amplify financial booms & busts
 Capture the monetary nature of the economy
What’s a Monetary
Economy ?

 1. Banking system doesn’t only transfer real
resources, but also generates nominal purchasing
power
 If deposits produced loans little problem in allocating
resources
 But loans creating deposits (may) create an excess
(part of MS)
 2. Dilute discipline’s heavy focus on eqbm
Monetary Economy

 Borio: saving is same as funding only in non-monetary
economies
 Saving IS unspent income while financing is the access to
(also borrowed) funds
 E.g. in economy without investment, saving = 0 but firms
still need to fund gap (buying input to revenue receipt)
 Gross (not net) capital flows finance credit booms;
 US boom funded domestically and from EU (nations with
CA < 0 )
 Net inflows are gross inflows less gross outflows
US BOP
Accounts 2011
($ Billions)


where’s Bernanke ?
murky link
between
CA surplus &
interest rates
 He doesn’t buy Bernanke’s savings glut: CA surplus nations (e.g.
China) funded U.S. credit boom, cutting world interest rates
 Saving & Investment affect “natural interest rate” not market
interest rates
 Natural interest rate: non-observable eqbm determined by real
factors
 Market rates (influenced by policy rates & yield curve) may deviate
from natural rates for long periods
 Borio: Natural rate an unlikely cause for imbalances leading to
2008 crisis
Dell’ariccia et al FCCC 11
The Good & the Bad of
Credit Booms

Good: Increases investment & consumption
Good: Contributes to financial deepening
Bad: May lead to crisis or sub-trend growth
Credit booms arise out of
financial reform
capital inflow surges
strong economic growth
Bad are likely to be larger & last longer, but can’t really tell
difference bad vs. good booms
When does Credit Boom
End in Credit Bust?

 Fast credit expansion brings vulnerability:
 Lax lending standards
 Excessive leverage
 Asset price bubbles
 Credit booms may go unnoticed:
 Inflation targeting central banks ignore M aggregates (may
overlook credit boom)
 Regulators’ focus on individual banks may lead to ignore
aggregate credit dynamics
 Professional consensus: M Policy too blunt to correct asset
P bubbles often coming with credit booms
Dell’arricia Study
Details

 Cross country with focus on bank credit (large share of
overall credit) => ignore bond markets, trade credit, etc
 Use data available to policymakers at the time, not
revisions coming post-decision
 Compare credit/GDP in each year and country to
trend between years t – 10 and t. Define as boom if :
 Deviation from trend > (1.5 x std dev) with annual
credit/GDP growth rate > 10% OR
 Annual credit/GDP growth > 20%
 Sample 170 countries with 175 boom episodes
Typical Credit Boom

 Median boom 3 years;
Credit/GDP grows 13% p.a.
(5 x all-year median growth)
 Most booms in middle-income
(also high-income) nations
 More booms in undeveloped
financial systems (median
credit/gdp at start of boom is
19% vs. 30% for entire sample)

 More countries suffer
credit boom since
deregulation of 1980s
Bernanke & Gertler’s
Financial Accelerator

 In upturn
 Rising borrower creditworthiness & collateral values
 Lenders supply more credit & may loosen lending
standards
 Greater credit allows greater investment and
consumption with another round of collateral value
rise
 Downturn, the opposite happens
Performance In Credit
Booms

 Faster GDP growth
 Fast-rising Asset P
 Inflation subdued
 Real exchange rate appreciates
 CA deficit (=> KFA surplus due
to foreign bank fund inflows)
Question 1 on Long Term

 Research uses credit/GDP to
measure financial development
that helps GDP growth
 1. Does credit boom bring
permanent financial deepening ?
 Some bring crises with sharp
drop in credit/GDP
 40% bring permanently higher
credit/GDP level (eqbm?)
(FIG 3 : credit growth in boom
positively related to long term
financial deepening 1970-2010)
Question 2

Is financial deepening via a
credit boom the same as
through gradual growth?
Positive correlation between
# years nation’s been in credit boom
Real GDP per capita growth since 1970
The Bad Side

 33% of booms followed within 3 years by banking crisis
Bad Side 2

 States with
greater booms
during
expansion
also suffered
larger
delinquencies
during bust
Bad Side 3

 Credit
booms
preceded
many of
largest
banking
crises of last
30 years
Bad Side 4

 60% of booms bring
below-trend growth (by
2.2%) over next 6 years
 Nations with bigger
credit/GDP changes
had deeper recessions
 Credit boom predicts
well “credit-less
recovery” (1/3 lower
average growth)
Find 3 factors linked to
start of Credit Boom

 33% of booms follow financial reform to increase
financial deepening
 Capital inflow surges (often due to liberalization)
increase funds in banks
 Booms start during or after strong economic growth
 Many countries can be affected simultaneously
 Financial liberalization occurs in several nations
simultaneously
 Capital inflows occur due to global liquidity conditions
Some Nations Are
More Susceptible

 Those pegging
exchange rate
(precludes M
policy to deal
with boom)
 Those expanding
M policy (low
borrowing cost
inflates asset P)
 Those with poor
bank supervision
Credit Boom Can Bring
Deepening or Crisis

 Define Bad if followed by banking crisis within 3 years or
brings recession or below-trend growth
 What’s there about boom to predict if it turns into crisis or
long sub-par GDP growth? Find BAD booms:
 Are larger and last longer
 Usually start with high credit/GDP
 Sometimes related to:




Higher inflation
larger CA deficits,
lower quality bank supervision
faster growing asset P