The Financial Cycle

Claudio Borio writes,

Financial liberalisation weakens financing constraints, supporting the full self-reinforcing interplay between perceptions of value and risk, risk attitudes and funding conditions. A monetary policy regime narrowly focused on controlling near-term inflation removes the need to tighten policy when financial booms take hold against the backdrop of low and stable inflation. And major positive supply side developments, such as those associated with the globalisation of the real side of the economy, provide plenty of fuel for financial booms: they raise growth potential and hence the scope for credit and asset price booms while at the same time putting downward pressure on inflation, thereby constraining the room for monetary policy tightening.

Pointer from Timothy Taylor.

Borio’s writing is a bit too colorful for my tastes. He uses exclamations! In a working paper!

Still, read the paper. There may be something to the idea that financial sector expansions and contractions are a phenomenon outside of the conventional macroeconomic model. I am quite sympathetic to that point of view.