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### I. Introduction — context and main conclusions
- Context:
  - Global financial crisis prompted major central banks, particularly the U.S. Federal Reserve, to lower policy rates to near zero and introduce measures to increase liquidity and stimulate credit.
  - Hong Kong SAR’s linked exchange rate system (LERS) imports the Fed’s monetary policy stance directly into the Hong Kong economy.
  - Potential risk: imported accommodative U.S. monetary policy combined with Hong Kong/Mainland economic improvement may create inflation in assets and goods markets via a financial accelerator process that raises collateral availability and fuels credit, potentially creating an asset prices–credit cycle.
- Main conclusions (as stated in the source):
  - A resumption of the credit channel in Hong Kong SAR and a turnaround in the money multiplier, has the potential to create inflation in both goods and asset markets.
  - Such expansionary financial conditions will have a greater impact in fueling asset price inflation, manifested in the model through a strong increase in equity prices.
  - Higher asset prices could, through a financial accelerator mechanism, in turn increase credit expansion and fuel an asset price-credit boom cycle.
  - Consumer price inflation will likely pick up but slower and to a much lesser extent since it will take time to unwind excess capacity in goods markets.
  - Fiscal policy could be used to restrain asset price increases but doing so will likely have a large impact on the real economy. As such, countercyclical prudential regulations may be a more appropriate tool to tackle such a credit-asset price cycle.

### II. The Fed’s unconventional monetary policy actions (implications for transmission)
- Policy rate changes and market impact:
  - The federal funds rate (FFR) was lowered from 5¼ percent to 0.16 percent between June 2007 and August 2009.
  - Despite this large reduction, high levels of risk aversion prevented the reduction of the FFR from translating into lower market rates.
- Categories of measures undertaken by the Fed:
  1. Creating new central bank facilities as well as loosening the terms and availability of existing facilities.
  2. Expanding the central bank’s balance sheets through purchases of government, government-guaranteed, or corporate securities from banks or other institutions.
  3. Alleviating financial distress in particular credit markets that are deemed to play a key role in supporting economic activity.
  4. Improving communication.
- Specific measures and scale:
  - New facilities to reduce stress in debt markets: AMLF, CPFF, MMIFF, and TALF.
  - Purchases of government or corporate securities to reduce rates on longer maturity government instruments:
    - In November, 2008 the Federal Reserve announced plans to purchase agency debt and by December the FOMC statement indicated the Fed would also begin purchasing long-term Treasuries.
    - By September 2009, the Fed was holding US$810 billion in agency debt and MBS and around US$760 billion in treasury securities.
  - Expanded liquidity provision: TAF, Term Securities Lending Facility, PDCF, and U.S. dollar liquidity via foreign currency swaps.

### III. Impact on Hong Kong SAR
- Monetary transmission and liquidity:
  - With the linked exchange rate system, Hong Kong SAR imported the Fed’s extraordinary measures.
  - Hong Kong’s base interest rates have been lowered to ½ percentage points (from 6¾ percent in mid 2007) alongside the reductions in the fed funds rate.
  - The HKMA purchased U.S. dollars and sold Hong Kong dollars resulting in a more-than-doubling of the monetary base (which reached HK$804 billion by end September 2009).
  - Demand for high quality and liquid instruments drove yields on exchange fund papers close to zero even up to 12 months maturities; excess demand prompted the HKMA to increase issuance of exchange fund bills, shifting funds from the aggregate balance to exchange fund papers.
- Money multiplier and credit:
  - Despite the rise in the monetary base, credit did not increase.
  - The money multiplier fell as banks became more cautious about new lending and uncertainties about the recovery restrained demand for credit.
  - The money multiplier is now around half where it was before the collapse of Lehman—implying that the large increase in Hong Kong dollar liquidity could translate into rapid credit growth should the monetary transmission re-establish itself.
- Sectoral and asset developments:
  - Burgeoning recovery in credit to particular sectors, notably real estate.
  - Equity market prices have rebounded; rebound partly related to strength of activity in the Mainland and factors such as low interest rates in major economies and declining global risk aversion.
  - Balance of payment data for the first half of this year shows a rebound in nonresident net equity holdings (data reported on a net basis).
- Financial accelerator transmission channels:
  - Higher asset prices can increase private consumption via wealth effects and raise collateral values, lowering the “external finance premium”.
  - Higher collateral reduces borrowers’ cost of capital, boosting credit, investment, private consumption, and growth.
  - Feedback loop: higher growth raises prospects for future profit and dividend income, lifting asset prices and net worth, further reducing the external finance premium and potentially creating a credit-asset price cycle.
- Timing and risks:
  - Goods price inflation could take longer to emerge than asset price increases due to large output gaps and anchored inflation expectations.
  - Asynchronous cycles in China and the United States and differing financial system health raise the potential for a credit-asset price cycle if U.S. monetary policy remains accommodative while Hong Kong SAR and the Mainland return to growth more rapidly.

### IV. Model overview (GIMF with financial accelerator) — structure and calibration
- Model and regional aggregation:
  - Expanded IMF Global Integrated Monetary and Fiscal model (GIMF) incorporating a financial accelerator.
  - 11 Asian economies combined into 5 regions: Australia-New Zealand, China, EMEAP6 (Hong Kong SAR, Indonesia, Malaysia, Philippines, Singapore, and Thailand), Japan, and South Korea; plus 2 advanced economies outside Asia (United States and the euro area) and the rest of the world.
- Main features and agents:
  - Agents: unions, manufacturers, capital producers, investment and consumption goods producers, distributors, households (overlapping generations and liquidity constrained), government, and banks.
  - Financial assets: households hold domestic and foreign currency denominated bonds.
  - Labor market: unions supply differentiated labor, buy from households and sell to manufacturers at a premium; unions face nominal rigidities.
  - Goods and trade: two-layer multilateral trade with tradables and nontradables; distributors combine domestic and foreign tradables with public infrastructure; nominal and real rigidities across sectors.
  - Entrepreneurs and banks: entrepreneurs finance capital with internal/external funds, face idiosyncratic shocks and bankruptcies; banks recover only a stochastic proportion of assets upon bankruptcies.
  - Financial sector: banks charge an external finance premium dependent on riskiness and perceived economic state; lower external finance premium reduces cost of capital—core of the financial accelerator.
  - Monetary policy: represented by Taylor rule under flexible exchange rates or managed/fixed regimes; Hong Kong SAR treated as fixed rate regime.
  - Fiscal policy: non-Ricardian features; fiscal policy aims to stabilize debt-to-GDP; public investment is productive.
- Calibration notes:
  - Calibration built on work with HKMA staff.
  - Financial variables initial steady states set with leverage ratios and borrower’s riskiness equal to 2 percent on average across firms.
  - Emerging Asian countries assumed to block peg their currencies to the U.S. dollar; other regions follow floating exchange rates.

### V. Scenario assumptions used in simulations
- U.S. scenario:
  - Activity in the United States remains weak with a persistent decline in private investment.
  - U.S. consumers increase their savings rate for an extended period to restore balance sheets.
  - Result: U.S. nominal interest rates about 100 basis points below baseline after two years and 20 basis points after 7 years.
  - Temporary shift in preferences toward domestically produced goods, reducing the relative share of imported goods.
- Mainland China stimulus:
  - Fiscal stimulus package over two years amounting to 4½ percent of GDP (3½ percent of GDP in the first year and 1 percent of GDP in the second year).
  - Stimulus composition: 2½ percent of GDP rise in government investment in the first year and ½ percent of GDP in the second year; reduction in the consumption tax of 1 percent of GDP in the first year and ½ percent of GDP in the second year.
- Hong Kong SAR assumptions:
  - As part of the EMEAP6 group, financial conditions ease temporarily relative to the United States as the monetary transmission reasserts itself.
  - Decline in borrowers’ riskiness and bankruptcy costs reduce the external finance premium by about 120 basis points relative to the baseline (roughly consistent with a decline in bank spreads to their mid-2006 levels).

### VI. Simulation results — dynamics and risks
- Output, demand, and exchange rate:
  - Output in Hong Kong SAR rises above the baseline as stronger demand for exports to the Mainland and easy financial conditions spur investment, profits, and private consumption.
  - Real depreciation supports export rise but is initially more than offset by a strengthening in imports, lowering the trade balance.
  - Household spending increases due to higher labor demand, higher wages, and increased capital income; tempered by negative effect of lower global interest rates on household foreign asset income.
- Investment, net worth, and asset prices:
  - Investment increases due to easier financing conditions, lower external finance premium, and increased credit demand.
  - Improved profit opportunities raise net worth of entrepreneurs and capital producers.
  - Asset prices rise much faster than goods prices, spurred by stronger activity, easy financial conditions, and feedback between real and financial variables.
  - Higher net worth lowers the external finance premium, further supporting activity and asset prices.
  - Comparable simulation without a financial accelerator shows no positive impact on asset prices in early years; slower U.S. demand dominates and credit growth remains subdued.
- Inflation and goods prices:
  - CPI inflation is higher but overall impact is moderate:
    - Demand reacts faster than supply initially because of adjustment costs, so CPI rises moderately but fades as supply increases catch up.
    - Inflationary pressure on goods prices likely to be even more subdued in reality due to a large open output gap in Hong Kong SAR.
- Risk of boom-bust dynamics:
  - Although the model does not allow unstable dynamics, the financial accelerator feedback could fuel an asset price-credit boom cycle, potentially leading to more extreme increases in asset and goods markets than simulated.
  - Such cycle is more likely to raise asset prices more than goods prices because goods prices are stickier.
  - Risk increases when interest rates are low relative to output growth and when it takes time to unwind excess capacity in goods markets; sustained rapid credit growth with rising asset prices raises likelihood of financial instability.

### VII. Policy analysis — fiscal policy versus prudential measures
- Fiscal policy to contain asset price increases:
  - Offsetting action with fiscal tightening would require substantial fiscal contraction and entail large output losses.
  - Model simulations suggest even a tightening of fiscal policy of 5 percent of GDP would be insufficient to fully counter the rise in asset prices but would exert a significant downward drag on the real economy.
  - Significant implementation lags reduce fiscal policy effectiveness in smoothing asset price movements.
- Role for alternative (prudential) policies:
  - Changes to prudential regulations could mitigate the upswing in asset prices and strengthen financial system resilience without large macroeconomic drag. Possible measures include:
    - Tighter underwriting standards.
    - Lower loan-to-value ratios.
    - Countercyclical capital adequacy requirements.

### VIII. Conclusions and policy implications
- Given Hong Kong’s linked exchange rate system, the outlook for U.S. monetary policy, and prospects for growth in Hong Kong SAR and China, there is a risk of a build up of a credit-asset price cycle in Hong Kong SAR.
- The evolution of this cycle depends critically on:
  - Resumption of the credit channel in Hong Kong SAR.
  - Increase in demand for credit.
  - Banks’ willingness to increase lending.
- Given current liquidity in the Hong Kong system, there is potential for rapid credit growth with consequent implications for property and equity prices.
- Fiscal policy could restrain the asset price cycle but would impose significant downdraft on output, consumption, and employment.
- Prudential policies (e.g., tighter underwriting standards, lower loan-to-value ratios, countercyclical capital adequacy requirements) may play an important role to mitigate the upswing in asset prices and strengthen the financial system’s ability to withstand subsequent unwinding of the cycle.

### Key statistics and figures (preserved exactly as in the source)
- Federal funds rate change: from 5¼ percent to 0.16 percent (June 2007 to August 2009).
- Fed holdings by September 2009:
  - US$810 billion in agency debt and MBS.
  - around US$760 billion in treasury securities.
- Hong Kong monetary base: HK$804 billion by end September 2009.
- Hong Kong base interest rates lowered to ½ percentage points (from 6¾ percent in mid 2007).
- Mainland China stimulus: 4½ percent of GDP over two years (3½ percent of GDP in the first year and 1 percent of GDP in the second year).
- Mainland stimulus composition: 2½ percent of GDP rise in government investment in the first year and ½ percent of GDP in the second year; reduction in the consumption tax of 1 percent of GDP in the first year and ½ percent of GDP in the second year.
- External finance premium decline in Hong Kong SAR simulation: about 120 basis points relative to the baseline.
- Fiscal tightening scenario referenced: 5 percent of GDP.

*Source: _wp09256 - References..............................................................................................................*

### References..............................................................................................................

### _wp09256 - References

### I. INTRODUCTION
- Context: Global financial crisis prompted major central banks, particularly the U.S. Federal Reserve, to lower policy rates to near zero and introduce measures to increase liquidity and stimulate credit.
- For Hong Kong SAR, the linked exchange rate system (LERS) imports the Fed’s monetary policy stance directly into the Hong Kong economy.
- Potential risk: Imported accommodative U.S. monetary policy combined with Hong Kong/Mainland economic improvement may create inflation in assets and goods markets via a financial accelerator process that raises collateral availability and fuels credit, potentially creating an asset prices–credit cycle.

- Main conclusions (as stated in the source):
  - A resumption of the credit channel in Hong Kong SAR and a turnaround in the money multiplier, has the potential to create inflation in both goods and asset markets.
  - Such expansionary financial conditions will have a greater impact in fueling asset price inflation, manifested in the model through a strong increase in equity prices.
  - Higher asset prices could, through a financial accelerator mechanism, in turn increase credit expansion and fuel an asset price-credit boom cycle.
  - Consumer price inflation will likely pick up but slower and to a much lesser extent since it will take time to unwind excess capacity in goods markets.
  - Fiscal policy could be used to restrain asset price increases but doing so will likely have a large impact on the real economy. As such, countercyclical prudential regulations may be a more appropriate tool to tackle such a credit-asset price cycle.

### II. IMPLICATIONS FOR HONG KONG SAR OF U.S. MONETARY POLICY

H3: The Fed’s Unconventional Monetary Policy Actions
- Policy rate changes:
  - The federal funds rate (FFR) was lowered from 5¼ percent to 0.16 percent between June 2007 and August 2009.
  - Despite this large reduction, high levels of risk aversion prevented the reduction of the FFR from translating into lower market rates.

- Rationale: The apparent breakdown in the monetary transmission mechanism in the U.S. prompted the Fed to take more dramatic steps aimed at tilting down the yield curve and stimulating credit creation.

- Categories of measures undertaken by the Fed (as listed in the source):
  1. Creating new central bank facilities as well as loosening the terms and availability of existing facilities.
  2. Expanding the central bank’s balance sheets through purchases of government, government-guaranteed, or corporate securities from banks or other institutions.
  3. Alleviating financial distress in particular credit markets that are deemed to play a key role in supporting economic activity.
  4. Improving communication.

- Specific measures described:
  - Creating new central bank facilities to respond to demand from specific credit markets:
    - Four facilities were introduced to reduce stress in debt markets through either direct government purchases or the provision of liquidity to allow financial institutions to purchase particular instruments: the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility (AMLF), Commercial Paper Funding Facility (CPFF), the Money Market Investor Funding Facility (MMIFF) and the Term Asset-Backed Securities Loan Facility (TALF).
  - Purchasing government or corporate securities to reduce rates on longer maturity government instruments:
    - In November, 2008 the Federal Reserve announced plans to purchase agency debt and by December the FOMC statement indicated the Fed would also begin purchasing long-term Treasuries.
    - By September 2009, the Fed was holding US$810 billion in agency debt and MBS and around US$760 billion in treasury securities.
  - Alleviating financial distress by expanding the scope of central bank liquidity provision:
    - In addition to the usual windows available to depository institutions, the Federal Reserve introduced the Term Auction Facility (TAF) to provide collateralized term funds to depository institutions, as well as the Term Securities Lending Facility and Primary Dealer Credit Facility (PDCF) to provide overnight and term funding to primary dealers.
    - The Fed has also provided U.S. dollar liquidity internationally through foreign currency swaps with other central banks.

### Key statistics and figures (preserved exactly as in the source)
- Federal funds rate change: from 5¼ percent to 0.16 percent (June 2007 to August 2009).
- Fed holdings by September 2009:
  - US$810 billion in agency debt and MBS.
  - around US$760 billion in treasury securities.

*Source: _wp09256 - References..............................................................................................................*

### 4.      Improving communications. The Fed has committed to maintain an accommodative

### _wp09256 - 4.      Improving communications. The Fed has committed to maintain an accommodative

### Impact on Hong Kong SAR
- With the linked exchange rate system, Hong Kong SAR has imported the extraordinary measures taken by the Fed.
- Hong Kong’s base interest rates have been lowered to ½ percentage points (from 6¾ percent in mid 2007) alongside the reductions in the fed funds rate.
- Large capital inflows, attracted to equity and property markets and drawn by banking system stability and the government credible deposit guarantee, led the HKMA to intervene as the Hong Kong dollar hit the strong side of the convertibility undertaking.
  - The HKMA purchased U.S. dollars and sold Hong Kong dollars resulting in a more-than-doubling of the monetary base (which reached HK$804 billion by end September 2009).
- Demand for high quality and liquid instruments drove yields on exchange fund papers close to zero even up to 12 months maturities.
  - Excess demand prompted the HKMA to increase issuance of exchange fund bills, shifting funds from the aggregate balance to the exchange fund papers (both part of the monetary base).
- Despite the rise in the monetary base, credit did not increase:
  - The money multiplier fell as banks became more cautious about new lending and uncertainties about the recovery restrained demand for credit.
  - The money multiplier is now around half where it was before the collapse of Lehman—implying that the large increase in Hong Kong dollar liquidity could translate into rapid credit growth should the monetary transmission re-establish itself.
- Sectoral signs:
  - Burgeoning recovery in credit to particular sectors, notably real estate.
  - Equity market prices have rebounded; rebound partly related to strength of activity in the Mainland and factors such as low interest rates in major economies and declining global risk aversion.
  - Balance of payment data for the first half of this year shows a rebound in nonresident net equity holdings (data reported on a net basis).
- Potential transmission from higher asset prices:
  - Higher asset prices can feed through to private consumption via wealth effects and raise eligible collateral value, lowering the “external finance premium”.
  - By posting higher collateral, borrowers reduce costs of capital, boosting demand for credit, investment, private consumption, and growth.
  - Financial accelerator mechanism: higher growth raises prospects for future profit and dividend income, lifting asset prices and net worth, which further reduces the external finance premium and can create a credit-asset price cycle affecting output, consumption, employment, and consumer price inflation.
- Timing of goods price inflation:
  - Macroeconomic effects, particularly goods price inflation, could take longer to emerge than asset price increases where there is a large output gap or stable inflation expectations anchored by a credible monetary framework.
- Risks heightened by asynchronous cycles:
  - Asynchronous cycles in China and the United States and differing health of financial systems raise the potential for a credit-asset price cycle if U.S. monetary policy remains accommodative while Hong Kong SAR and the Mainland return to growth more rapidly.

### Model overview (GIMF with financial accelerator)
- Model used: expanded IMF Global Integrated Monetary and Fiscal model (GIMF) that incorporates a financial accelerator mechanism and includes 11 Asian economies combined into 5 regions (Australia-New Zealand, China, EMEAP6 (Hong Kong SAR, Indonesia, Malaysia, Philippines, Singapore, and Thailand), Japan, and South Korea), 2 advanced economies outside Asia (United States and the euro area), and the rest of the world.
- Main model features:
  - Agents: unions, manufacturers, capital producers, investment and consumption goods producers, distributors, households (two types: overlapping generations and liquidity constrained), government, and banks.
  - Financial assets: households with access to financial markets hold domestic currency denominated bonds and foreign currency denominated bonds.
  - Labor market: unions supply differentiated labor, buy from households and sell to manufacturers at a premium; unions face nominal rigidities.
  - Goods market and trade: two-layer multilateral trade—manufacturers produce tradables and nontradables; distributors combine domestic and foreign tradables with public infrastructure to produce final goods; nominal and real rigidities exist across manufacturers, distributors, retailers, and importers.
  - Entrepreneurs and banks: entrepreneurs finance capital with external and internal financing and face idiosyncratic shocks causing bankruptcies; banks recover only a stochastic proportion of assets upon bankruptcies.
  - Financial sector: banks lend to entrepreneurs and charge an external finance premium dependent on riskiness and perceived state of the economy; lower external finance premium reduces cost of capital and stimulates investment and consumption—core of the financial accelerator.
  - Monetary policy: characterized either by a Taylor rule under flexible exchange rates or by managed float/fixed regimes where exchange rate smoothing or exchange rate stabilization can be objectives (Hong Kong SAR treated as fixed rate regime).
  - Fiscal policy: non-Ricardian features—finite lifetimes, liquidity constrained households, declining labor productivity with age, distortionary taxes; fiscal policy aims to stabilize debt-to-GDP; public investment is productive.
- Calibration notes:
  - Calibration built on work with HKMA staff.
  - Financial variables initial steady states set with leverage ratios and borrower’s riskiness equal to 2 percent on average across firms.
  - Emerging Asian countries assumed to block peg their currencies to the U.S. dollar; other regions follow floating exchange rates.

### Model simulations: scenario and assumptions
- U.S. scenario:
  - Activity in the United States remains weak with a persistent decline in private investment.
  - U.S. consumers increase their savings rate for an extended period to restore balance sheets.
  - Result: U.S. nominal interest rates about 100 basis points below baseline after two years and 20 basis points after 7 years.
  - Temporary shift in preferences toward domestically produced goods, reducing the relative share of imported goods.
- Mainland China stimulus:
  - Fiscal stimulus package over two years amounting to 4½ percent of GDP (3½ percent of GDP in the first year and 1 percent of GDP in the second year).
  - Stimulus composition: 2½ percent of GDP rise in government investment in the first year and ½ percent of GDP in the second year; reduction in the consumption tax of 1 percent of GDP in the first year and ½ percent of GDP in the second year.
- Hong Kong SAR assumptions:
  - As part of the EMEAP6 group, financial conditions ease temporarily relative to the United States as the monetary transmission reasserts itself.
  - Decline in borrowers’ riskiness and bankruptcy costs reduce the external finance premium by about 120 basis points relative to the baseline (roughly consistent with a decline in bank spreads to their mid-2006 levels).

### Simulation results and interpretation
- Output and demand:
  - Output in Hong Kong SAR rises above the baseline as stronger demand for exports to the Mainland and easy financial conditions spur investment, profits, and private consumption.
  - Real depreciation supports export rise but is initially more than offset by a strengthening in imports, lowering the trade balance.
  - Household spending increases due to higher labor demand, higher wages, and increased capital income (dividends); tempered by negative effect of lower global interest rates on household foreign asset income.
- Investment and net worth:
  - Investment increases due to easier financing conditions, lower external finance premium, and increased credit demand.
  - Improved profit opportunities raise net worth of entrepreneurs and capital producers.
- Exchange rate and inflation:
  - Real effective exchange rate depreciates as weak U.S. demand and lower U.S. interest rates weaken the U.S. dollar (which the Hong Kong dollar follows).
  - CPI inflation is higher but overall impact is moderate:
    - Demand reacts faster than supply initially because of adjustment costs, so CPI rises moderately but fades as supply increases catch up.
    - Inflationary pressure on goods prices likely to be even more subdued in reality due to a large open output gap in Hong Kong SAR.
- Asset prices and financial accelerator:
  - Asset prices rise much faster than goods prices, spurred by stronger activity, easy financial conditions, and feedback between real and financial variables.
  - Higher profits, investment, private consumption, and output increase firms’ net worth and raise asset prices; higher net worth lowers the external finance premium, further supporting activity and asset prices.
  - The rise in asset prices hinges on the presence of the financial accelerator, increased collateral, lower external finance premium, and improved financial intermediation.
  - A comparable simulation without a financial accelerator shows no positive impact on asset prices in early years; slower U.S. demand dominates and credit growth remains subdued.
- Risk of boom-bust dynamics:
  - Although model does not allow unstable dynamics, the financial accelerator feedback could fuel an asset price-credit boom cycle, potentially leading to more extreme increases in asset and goods markets than simulated.
  - Such cycle is more likely to raise asset prices more than goods prices because goods prices are stickier.
  - Risk increases when interest rates are low relative to output growth and when it takes time to unwind excess capacity in goods markets; sustained rapid credit growth with rising asset prices raises likelihood of financial instability.

### Fiscal policy and alternative measures
- Containing asset price increases via fiscal policy:
  - Offsetting action with fiscal tightening would require substantial fiscal contraction and entail large output losses.
  - Model simulations suggest even a tightening of fiscal policy of 5 percent of GDP would be insufficient to fully counter the rise in asset prices but would exert a significant downward drag on the real economy.
  - Significant implementation lags reduce fiscal policy effectiveness in smoothing asset price movements.
- Role for alternative policies (prudential measures):
  - Changes to prudential regulations could mitigate the upswing in asset prices and strengthen financial system resilience without large macroeconomic drag. Possible measures include:
    - Tighter underwriting standards.
    - Lower loan-to-value ratios.
    - Countercyclical capital adequacy requirements.

### Conclusions
- Given Hong Kong’s linked exchange rate system, the outlook for U.S. monetary policy, and prospects for growth in Hong Kong SAR and China, there is a risk of a build up of a credit-asset price cycle in Hong Kong SAR.
- The evolution of this cycle depends critically on:
  - Resumption of the credit channel in Hong Kong SAR.
  - Increase in demand for credit.
  - Banks’ willingness to increase lending.
- Given current liquidity in the Hong Kong system, there is potential for rapid credit growth with consequent implications for property and equity prices.
- Fiscal policy could restrain the asset price cycle but would impose significant downdraft on output, consumption, and employment.
- There may be an important role for prudential policies (e.g., tighter underwriting standards, lower loan-to-value ratios, countercyclical capital adequacy requirements) to mitigate the upswing in asset prices and strengthen the financial system’s ability to withstand subsequent unwinding of the cycle.

*Source: _wp09256 - 4.      Improving communications. The Fed has committed to maintain an accommodative*

### References

### _wp09256 - References

### Academic articles and working papers
- Bernanke, B., M. Gertler, and S. Gilchrist, 1999, “The Financial Accelerator in a Quantitative Business Cycle Framework,” in Handbook of Macroeconomics, ed. by J. Taylor and M. Woodford (Amsterdam: Elsevier).
- Borio , Claudio, and Andrew Filardo, 2003, “A Tale of Two Perspectives: Old or New Challenges For Monetary Policy?” BIS Working Paper No. 127 (Basel: Bank for International Settlements).
- Borio, Claudio, and Philip Lowe, 2002, “Asset Prices, Financial and Monetary Stability: Exploring the Nexus,” BIS Working Paper No. 114 (Basel: Bank for International Settlements).
- Yanagawa N., and G. M. Grossman, 1992, “ Asset Bubbles and Endogenous Growth”, NBER Working Paper No. 4004 (Cambridge, Massachusetts: National Bureau of Economic Research).

### IMF and related policy research
- International Monetary Fund, 2009, Global Financial Stability Report, October 2009: Navigating the Financial Challenges Ahead, World Economic and Financial Surveys (Washington).
- Kumhof, M., D. Laxton, D. Muir, and S. Mursula, 2009, “The Global Integrated Monetary and Fiscal Model: Theoretical Structure,” IMF Working Paper (forthcoming).
- N’Diaye, P. M’B. P., P. Zhang, and W. Zhang, 2009, “Structural Reform, Intra-Regional Trade, and Medium-Term Growth Prospects of East Asia and the Pacific—Perspectives From a New Multi-Region Model,” Journal of Asian Economics.

*Source: _wp09256 - References*

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