Political and Institutional Determinants of Credit Booms

Abstract

The literature that investigates credit booms has essentially focused on their economic determinants. This paper explores the importance of political conditionings and central bank independence and provides some striking findings on this matter. Estimating a fixed effects logit model over a panel of developed and developing countries for the period 1975q1–2016q4, we find that credit booms are less likely when right‐wing parties are in office, especially in developing countries, and when there is political instability. However, they have not proven to depend on the electoral cycle. More independent Central Banks are also found to reduce the probability of credit booms. Moreover, they seem to be more likely to occur and spread within a monetary union.

The collapse of credit booms: a competing risks analysis

“…This result is partially in line with the findings provided byCastro and Martins (2019), in the sense that if credit booms tend to be cut shorter under more independent monetary authorities, they will also be less likely to occur when that independence prevails.…”

“…Fourth, financial reforms and broad domestic differences are also highlighted, particularly reforms associated with financial liberalization, domestic expansionary monetary and fiscal policies, less flexible exchange rate regimes and frailties in the supervision of the banking system are all found to increase the occurrence of credit booms (Mendoza and Terrones 2012;Elekdag and Wu 2013;Arena et al, 2015;Dell'Ariccia et al, 2016). More recently, Castro and Martins (2019) extend the analysis of credit booms to the role of the political environment and find that credit booms are less likely when right-wing parties are in office, especially in developing countries, and when there is political instability. They also show that Central Bank independence reduces the probability of credit booms.…”

“…They also show that Central Bank independence reduces the probability of credit booms. This paper, besides exploring the multiple economic determinants of credit booms discussed in the literature, borrows from Castro and Martins (2019) and also investigates the importance of government stability and Central Bank independence (CBI) on the duration and outcomes of credit booms. A higher degree of government stability -like the government's ability to carry out its programme or to stay in office -can lead to a more stable economic environment, thus favouring longer credit surges.…”

Riding the Wave of Credit: Are Longer Expansions Really a Bad Omen?

“…The investigation on credit booms has been conducted mainly through data analysis and the literature has highlighted the association between credit expansions and macroeconomic dynamics. Rises in capital inflows, productivity shocks and general improvements in the economy, allied to excessive optimism, are found to explain the build-up of such events (see, for instance, Terrones 2008, 2012;Dell'Ariccia et al 2016;Amri et al 2016;Avdjiev et al 2018;Castro and Martins 2019). Additionally, financial reforms associated with financial liberalization and domestic differences such as expansionary monetary and fiscal policies, less flexible exchange rate regimes, debt composition and weak supervision of the banking system are also associated with periods of abnormal credit growth (Elekdag and Wu 2013;Arena et al 2015;Dell'Ariccia et al 2016;Avdjiev et al 2018).…”

“…Estimating a fixed effects logit model over a panel of developed and developing countries, Castro and Martins (2019) show that credit booms depend not only on the quantity of credit but are also influenced by its relative price. Likewise, economic growth and economic openness also build-up the conditions for the appearance of lending booms.…”