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Monday, August 13, 2012

How the accelerator effect works

Syndicated leverage loan market 1998-2011 
 Indicates how financial markets coincide with economic conditions

Monetary policy and financial regulation influence lending activity
Market performance is linked to economic conditions, but may not reflect them

The accelerator effect is the outcome financial circumstances relating to business and market outlays in terms of specific economic conditions. According to former chairman of the Federal Reserve Board, Ben Bernanke, the accelerator is itself a change to “financial and credit conditions” that affects the business operating environment. For example, if interest rates rise, the cost of capital also rises; if the business environment is experiencing a down-cycle, then the rising interest rates are thought to accelerate the negative impact of the business down-cycle which in turn influences economic conditions. 

A key function of the accelerator effect is to explain why certain financial conditions occur. When a cause for specific events can be proven to be the accelerator effect, then the reason for fiscal circumstances and actions can be illustrated and justified with more validity. For example, in a research study by an Bruno Coric Phd of the University of Spilt, it is claimed the accelerator effect itself serves as a model with which changes to business “outputs” are related to financial markets. In other words, the accelerator effect is a substantiated economic tool in the context of which economic scenarios are made clearer.

Even though there is some explanatory power to the accelerator effect, it is not completely illustrative of economically related financial scenarios. Moreover, as Ben Bernanke of the Federal Reserve and  Simon Hall of the Bank of England point out, the scenario described as the accelerator effect is not due to unique causes. Moreover, other variables also influence the economy which impact the accuracy of the accelerator effect as an explanatory tool. For example, even if financial obstacles such as access to financing are prevented from inhibiting business operation, there is still the question of how using available money would be profitably beneficial. 

Measurement of both economic and financial impact is also a key function of the accelerator effect. In a report by Amundi Asset Management the accelerator effect is measured by determining the quantitative changes to corporate investment behavior when economic stress is experienced in money supply, loans to firms, credit conditions and employment. To explain further, by gathering economic and corporate data, trend lines or 'financial affects' are measured. When these trends are statistically correlated to preceding and separate but similar economic scenarios, the impact of the accelerator affect can be numerically illustrated and corroborated.

Guidance is another function of the accelerator affect. The more an economic event can be demonstrated to be the accelerator effect, the greater the perceived utility of specific forms of monetary policy become. In other words, the affects of adjusting monetary policies to influence economic conditions are in part substantiated by the accelerator effect. In this context, if the cause of the financial accelerator is inhibited, the consequence in theory would be a reduction in the ability of that financial mechanism to amplify its economic impact leading to a change in the accelerator effect.

Image license: US-PDGov