Financial sector pro-cyclicality: lessons from the crisis
We analyze the main forces affecting financial system pro-cyclicality (the fact that developments in the financial sector can amplify business cycle fluctuations). We first review some major structural developments in financial markets that may influence pro-cyclicality and that have been overlooked in earlier analyses. We then examine three issues that are center stage in the current debate: capital regulation, accounting standards and managersï¿½ incentives. After reviewing the institutional set-up and the key mechanisms at work, we critically examine a series of proposals designed to mitigate pro-cyclicality.
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