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Procyclicality of Financial Systems in Asia pp 55–123Cite as

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Sources of Procyclicality in East Asian Financial Systems

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Abstract

In most countries, financial systems are procyclical. Credit to the non-financial private sector typically increases when output is expanding and contracts during recessions, while asset prices respond to favorable growth expectations. Procyclicality is a normal consequence of the process through which the financial system finances economic growth. However, the experience of some emerging markets and OECD countries, where rapid credit growth and asset price bubbles have preceded sharp cyclical downturns, often accompanied by episodes of financial instability, suggests that features of the financial system can exacerbate the cycle. Interest in this issue has been heightened by the strong output growth coupled with rapid credit growth and asset price inflation in many Asian countries. This has contributed to concerns that a build-up of risk in financial systems could exacerbate the cyclical downturn, as it did in a number of countries in 1997–8. This chapter identifies features of financial systems that have the potential to exacerbate procyclicality and empirically assesses their importance for eleven East Asian economies, five of which are “advanced” (Australia, Hong Kong, Japan, New Zealand, Singapore) and six of which are “emerging market economies” (China, Indonesia, Korea, Malaysia, Philippines, Thailand).

This paper should not be reported as representing the views of the IMF. The views expressed are those of the authors and do not necessarily reflect the views of the IMF or IMF policy.

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  1. R. Sean Craig
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  2. E. Philip Davis
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  3. Antonio Garcia Pascual
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  1. Monetary and Financial Systems Department, International Monetary Fund, USA

    Paul Gruenwald

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© 2006 International Monetary Fund

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Craig, R.S., Davis, E.P., Pascual, A.G. (2006). Sources of Procyclicality in East Asian Financial Systems. In: Gerlach, S., Gruenwald, P. (eds) Procyclicality of Financial Systems in Asia. Procyclicality of Financial Systems in Asia. Palgrave Macmillan, London. https://doi.org/10.1057/9781137001535_6

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