KIEL ECONOMIC POLICY PAPERS 2 Procyclicality in the Financial System: Do We Need a New Macrofinancial Stabilization Framework?

Economic liberalization almost everywhere has constituted a positive supply shock which has been profoundly disinflationary at the global level. Financial liberalization in the industrial countries has also given fuller rein to inherent tendencies towards “procyclicality”, a process of credit creation leading to asset price increases and heavy fixed investment which can amplify the business cycle. Monetary authorities in the industrial countries have generally been able to follow easier policies than otherwise given the absence of inflationary pressures. Monetary authorities in emerging market economies, particularly in Asia, have also eased in an attempt to offset the upward pressure on their currencies resulting from ease elsewhere. Given this combination of circumstances, there has been no systematic resistance to the financial sector’s inherent tendencies to overreach.