DP14492 Growth-and-Risk Trade-off

Author(s): Maria Dolores Gadea Rivas, Luc Laeven, Gabriel Pérez-Quirós
Publication Date: March 2020
Keyword(s): business cycles, credit growth, macroprudential policies
JEL(s): C22, E32, E61
Programme Areas: International Macroeconomics and Finance
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=14492

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.