Financial Cycles and the Real Economy
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Financial Cycles and the Real Economy

Lessons for CESEE Countries

Edited by Ewald Nowotny, Doris Ritzberger-Grünwald and Peter Backé

What is the link between the financial cycle - financial booms, followed by busts - and the real economy? What is the direction of this link and how salient is this connection? This unique book examines these fundamental questions and offers a paramount contribution to the debate surrounding the recent financial and economic crisis.
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Chapter 2: The financial cycle and macroeconomics: what have we learned and what are the policy implications?

Claudio Borio


Understanding in economics does not proceed cumulatively. We do not necessarily know more today than we did yesterday. So-called lessons are learnt, forgotten, relearnt and forgotten again. Concepts rise to prominence and fall into oblivion before possibly resurrecting. They do so because the economic environment changes, sometimes slowly but profoundly, at other times suddenly and violently. But they do so also because the discipline is not immune to fashions and fads, either. The notion of the financial cycle, and its role in macroeconomics, is no exception. The notion of financial booms followed by busts actually predates the much more common and influential notion of the business cycle (e.g., Zarnowitz, 1992; Laidler, 1999; Besomi, 2006). But for most of the post-war period it featured only outside the mainstream (e.g., Minsky, 1982; Kindleberger, 2000). Indeed, financial factors in general progressively disappeared from macroeconomists’ radar screen: finance was seen as a factor that could be ignored when seeking to understand business fluctuations (e.g., Woodford, 2003). And when included at all, it would at most enhance the persistence of the impact of economic shocks that buffet the economy, delaying slightly its natural return to the steady state (e.g., Bernanke et al., 1999).

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