Broadly, these models can be classified according to the underlying micro-economic friction. For example, a well-established body of literature has looked at the effects of asymmetric information between borrowers and lenders in placing limits on credit (Bernanke, Gertler and Gilchrist (1996), Holstrom and Tirole (1997)). These constraints can be loosened by the borrower pledging collateral to the lender, in effect as a substitute for information (Kiyotaki and Moore (1997)). This solves one problem, but at the potential expense of another: movements in the prices of collateral then have the potential to aggravate cycles in leverage and credit (Geanakoplos (2010)). These cycles can in turn act as a “financial accelerator” for the business cycle. These are typically models of a representative bank and creditconstrained investor. A second potential source of credit market friction arises from coordination failures among lenders (Gorton and He (2008)). In these models, banks are heterogeneous and their behaviour strategic. The individually rational actions of heterogeneous lenders can generate collectively sub-optimal credit provision in both the upswing (a credit boom) and the downswing (a credit crunch), perhaps through herding (Acharya (2009), Acharya and Yorulmazer (2008)). This is the result of a collective action, or co-ordination, problem among banks. In credit markets, these co-ordination failures are far from new. Keynes memorably noted: “A sound banker, alas, is not one who foresees danger and avoids it, but one who, when he is ruined, is ruined in a conventional and orthodox way with his fellows, so that no one can really blame him” (Keynes (1931)).

Andrew G Haldane: Curbing the credit cycle Speech presented by Andrew G Haldane, Executive Director, Financial Stability, Bank of England, at the Columbia University Center on Capitalism and Society Annual Conference, New York, 20 November 2010. *  *  *  The speech was prepared by Messrs David Aikman, Andrew G Haldane and Benjamin Nelson. The views are not necessarily those of the Bank of England. We are grateful to Piergiorgio Alessandri, Richard Barwell, Salina Ladha, Roland Meeks, Victoria Saporta and Alan Taylor for comments. Thanks to Vijay Balle and Clare Rogowski for excellent research assistance and to Moritz Schularick and Alan Taylor for making their data available to us. 1. Introduction  Credit lies at the heart of crises. Credit booms sow the seeds of subsequent credit crunches. This is a key lesson of past financial crashes, manias and panics (Minsky (1986), Kindleberger (1978), Rogoff and Reinhart (2009)). It was a lesson painfully re-taught to policymakers during the most recent financial crisis. This time’s credit cycle has been particularly severe and synchronous. In 2006, private sector credit across the UK, US and euro area rose by around 10%. During 2009, private credit in these countries fell by around 2%. 1 The knock-on consequences for real growth were equally severe and synchronous. Peak to trough, G7 real output fell by 3.6% during the Great Recession. In response, there have been widespread calls for remedial policy action. These proposals come in various stripes.