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This paper explores the link between monetary policies of large industrial countries and international credit cycles. Based on an overinvestment framework, we show that in the prevailing asymmetric world monetary system, monetary policies of large centre countries can fuel credit booms in emerging markets. We argue that the absorption of inflationary pressure by emerging markets during boom periods as well as the fear of feedback effects of crises in emerging markets encourage delayed monetary tightening in centre countries. The paper helps explain asymmetric monetary policy patterns in centre countries and why the current global low interest rate environment is likely to prevail.

In this paper we extend the behavioral macroeconomic model as proposed by De Grauwe (2012) to include a banking sector. The behavioral model takes the view that agents have limited cognitive limitations. As a result, it is rational to use simple forecasting rules and to subject the use of these rules to a fitness test. Agents then are driven to select the rule that performs best. The behavioral model produces endogenous and self-fulfilling movements of optimism and pessimism (animal spirits). Our main result is that the existence of banks intensifies these movements, creating a greater scope for booms and busts. Thus banks do not create but amplify animal spirits. The policy conclusion we derive from this result is that the central bank has an important responsibility for stabilizing output. Output stabilization is an instrument to "tame the animal spirits". This has the effect of improving the tradeoff between inflation and output volatility.