Discussion Paper Details

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Title: Growth-and-Risk Trade-off

Author(s): Maria Dolores Gadea Rivas, Luc Laeven and Gabriel Pérez-Quirós

Publication Date: March 2020

Keyword(s): business cycles, credit growth and macroprudential policies

Programme Area(s): International Macroeconomics and Finance

Abstract: We study the effects of credit over the business cycle, distinguishing between expansions and contractions. We find that there is a growth and risk trade-off in the pace of credit growth over the business cycle. While rapid credit growth tends to be followed by deeper recessions, we also find that credit growth has a positive impact on the duration of expansions. This poses a trade-off for the policymaker: Limiting the buildup of financial risk to avoid a deep recession can negatively affect the cumulation of economic growth during the expansion. We show that intermediate levels of credit growth maximize long-term growth while limiting volatility. Macroprudential policies should be used to manage this growth and risk trade-off, striking a balance between allowing expansions to last longer and avoiding deep recessions.

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Bibliographic Reference

Gadea Rivas, M, Laeven, L and Pérez-Quirós, G. 2020. 'Growth-and-Risk Trade-off'. London, Centre for Economic Policy Research.