The Aftermath of Credit Booms: Evidence from Credit Ceiling Removals

Abstract

In the years after WWII, many countries adopted “credit ceilings” – annual restrictions on the quantity of aggregate credit banks could extend – as a means of monetary control. We identify a group of 13 countries that enacted and subsequently removed credit ceilings and study the aftermath of these deregulatory events, with an eye towards understanding the formation of credit booms and the events that follow them. We find that a removal of credit ceilings predicts sharp, sudden increases in credit-to-GDP ratios, which, almost universally, are followed by increases in investment, real estate construction, and asset prices over the short-term, and then by reversals and banking crises in the medium-run. These credit booms are driven by the types of banks and loans most affected by deregulation, and the timing is most consistent with credit ceiling removals relative to other types of financial deregulations that happened in the same era. We uncover several new phenomena related by credit booms, including the asynchronous nature of GDP and credit growth and “calm before the storm” phenomenon described in theory by Greenwood, Hanson, and Jin (2019); “successive bubbles,” as asset price booms inflate and reverse in succession; and the “irreversibility” of credit booms. Our results have implications today for macroprudential policy and for credit control policies in countries such as China.