DP7570 Credit Booms Gone Bust: Monetary Policy, Leverage Cycles and Financial Crises, 1870-2008

Author(s): Moritz Schularick , Alan M. Taylor

Publication Date: November 2009

Date Revised: July 2011

Keyword(s): banking , central banking , financial stability , liquidity , monetary policy

JEL(s): E44 , E51 , E58 , G01 , G20 , N10 , N20

Programme Areas: International Macroeconomics

Initiatives: Economic History

Link to this Page: www.cepr.org/pubs/dps/DP7570.asp.asp

The crisis of the advanced economies in 2008-09 has focused new attention on money and credit fluctuations, financial crises, and policy responses. We study the behavior of money, credit, and macroeconomic indicators over the long run based on a new historical dataset for 14 countries over the years 1870-2008, using the data to study rare events associated with financial crisis episodes. We present new evidence that leverage in the financial sector has increased strongly in the second half of the twentieth century as shown by a decoupling of money and credit aggregates. We show for the first time how monetary policy responses to financial crises have been more aggressive post-1945, but how despite these policies the output costs of crises have remained large. Importantly, we demonstrate that credit growth is a powerful predictor of financial crises, suggesting that such crises are 'credit booms gone wrong' and that policymakers ignore credit at their peril. It is only with the longrun comparative data assembled for this paper that these patterns can be seen clearly.