Financial Crises, Macroprudential Policy and the Reliability of Credit-to-GDP Gaps

Abstract

The Basel III regulation explicitly prescribes the use of Hodrick-Prescott filters to estimate credit cycles and calibrate countercyclical capital buffers. However, the filter has been found to suffer from large ex-post revisions, raising concerns over its fitness for policy use. To investigate this problem, we studied the credit cycles of a panel of 26 countries between 1971 and 2018. We reached two conclusions. The bad news is that the limitations of the one-sided HP filter are serious and pervasive. The good news is that they can easily be mitigated. The filtering errors are persistent and hence predictable. This can be exploited to construct real-time estimates of the cycle that are less subject to ex-post revisions, forecast financial crises more reliably, and stimulate the build-up of bank capital before a crisis.

Analysis of capital buffers in Serbia

“…On the other hand, authors such as Darracq Pariès, Fahr and Kok (2019) suggest that the credit-to-GDP gap could be downward, after prolonged credit growth, to the extent that this growth causes an increase in bias in the estimated trend component. Based on an analysis by Alessandri, Bologna and Galardo (2021), it is recommended to assess the gap between credit and GDP from its long-term trend using a two-sided HP filter.…”

Financial Cycles – Early Warning Indicators of Banking Crises?

“…Using spectral analysis and unobserved components models, Gonzales et al (2015) find that financial cycles are the same length as business cycles in several emerging markets. Moreover, critical views on the approaches used for cycle extraction, including dependence on HP filters -and the spurious results introduced by some of these approaches -contributed to the debate on financial cycles (Harvey and Jaeger, 1993;Harvey and Trimbur, 2008;Hamilton, 2018;Alessandri et al, 2021).…”