Credit is debt, debt is credit. And yet, these two terms have contrasting reputations. While the word debt has a negative connotation, credit gives rise to positive associations. The double-edged nature of credit and debt is also evident from an economic perspective.

On the one hand, credit is one of the cornerstones of a successful economy based on the division of labour. It allows borrowers to put their expected income to the best-possible use over time and provides lenders with the opportunity to invest their accrued assets in an optimal way. For an economy as a whole, an efficient credit system is thus a key driver of growth and prosperity.

On the other hand, credit is always associated with risk. Defaulting on a credit can affect both lenders and borrowers. An excessive build-up of debt is problematic for the macroeconomy as it means there is a greater likelihood of extensive defaulting on loans, and hence an actual debt crisis. Such crises often have far-reaching consequences. For one, credit crises are often associated with deeper recessions than in a normal economic cycle. At the same time, economic recovery after a credit crisis is often more sluggish than usual.

Despite these findings, excesses in the credit market, which ultimately end in a crisis, occur time and again. A number of closely related factors all play a role in this phenomenon. First, a favourable macroeconomic environment drives the supply and demand of loans. Second, the rational reaction of individual lenders and borrowers to the favourable environment can lead to a build-up of systemic risks. And, third, over-optimistic expectations of economic agents also play a role.

How can the downsides of excessive lending be kept in check, at the same time preserving the wealth-creating aspect of a sustainable credit system? What kind of a role can and should central banks be playing?

In order to fulfil their legal mandate to ensure price stability while taking due account of economic developments, central banks influence, among other things, credit market conditions. It is possible that, for price stability reasons, interest rates have to be kept low for a prolonged period. Over time, however, this may lead to excesses in the credit market. The current situation in Switzerland is a case in point - the fact that interest rates around the globe have been trending downwards for many years now, coupled with the continuing strength of the Swiss franc since its appreciation in the recent financial crisis, means that the Swiss National Bank has been having to keep interest rates low for several years now. As a result of the worldwide fall in interest rates, mortgage rates in Switzerland have been on a downward trend for some 25 years. This has contributed to a build-up of imbalances on the mortgage and real estate markets.

Macroprudential instruments have globally grown in importance since the financial crisis as they are a means of countering excesses on the credit market. It would, however, be presumptuous to assume that these macroprudential instruments might be able to curb each and every risk to financial stability. It is thus of central importance that all economic agents in the credit market always exercise sufficient caution and restraint.