Economics in a picture
The Countercyclical Capital Buffer stabilizes output fluctuations when GDP and credit co-move
The main goal of the Countercyclical Capital Buffer (CCyB) is to establish adequate capital buffers in periods when credit expansion is considered excessive and to promptly allow for a buffer reduction in periods of credit shortage. The figure reports the stabilization performance of the CCyB on a general equilibrium model. The scenario is based on overly optimistic expectations, which trigger a boom in the economy, followed by a reversal in those same expectations, which generates a subsequent bust. This is for example the case when there are expectations of improved entrepreneurial risk. In this case GDP and credit depict a strong co-movement in the same direction.
The buffer accumulation during the credit expansion phase implies a more moderate decline of the wholesale interest rate spread vis-à-vis the scenario without CCyB, so that banks are able to generate larger profit margins and retain the additional earnings. This in turn implies a more moderate increase in credit and output during the expansion phase. The buffer provides a cushion for the banking system when credit losses emerge during the recession phase. In this phase, the release of the buffer implies that credit restrictiveness becomes less severe and the wholesale interest spread faces a more moderate increase, vis-à-vis the scenario without CCyB. This in turn cushions the feedback triggered by the losses in the banking system to a fragile entrepreneurial sector, taming the severity of the contraction.
For further details see Paulo Júlio and José R. Maria (2019), “The countercyclical capital buffer: A DSGE approach”, Banco de Portugal Economic Studies, Vol. 5, pp. 47-66.
Prepared by Paulo Júlio and José R. Maria. The analysis, opinions and results expressed herein are the sole responsibility of the authors and do not necessarily coincide with those of Banco de Portugal or the Eurosystem.
If you want to receive an e-mail whenever a new “Economics in a picture” is published send your request to email@example.com.