What is a 'Financial Accelerator'

A financial accelerator is a means by which developments in financial markets amplify the effects of small changes in income on the economy. Conditions in financial markets and the economy may reinforce each other resulting in a feedback loop. The idea is attributed to Federal Reserve Board Chairman Ben Bernanke and economists Mark Gertler and Simon Gilchrist.

BREAKING DOWN 'Financial Accelerator'

To illustrate this idea, it is helpful to consider how a shock to the income of companies and households would affect their capacity to borrow, and hence, their effect on the broader economy. That is, a small increase in income could produce an inordinate rise in spending because it would not only provide more disposable income but also increase a household borrowing capacity, potentially boosting spending further.

This idea has been tested in international housing markets. One study examined Italy, where the loan-to-value ratio on residential mortgages have not exceeded 60%, and the U.K., where for the past 20 years, LTV ratios have averaged 90%. Essentially, the financial accelerator idea suggests that in the U.K., the high LTV country, housing prices should be more sensitive to changes in household income than they are in Italy. That is, because the U.K. homebuyer can borrow more, given the same change in income, home prices in the U.K. should respond more to changes in household income.

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