Washington, D.C., May 1, 2014 - Monetary policymakers face difficult decisions ahead when comparing current trends in credit growth with asset valuation, according to a new research note by the Institute of International Finance.

In its May edition of the Capital Markets Monitor, the IIF takes a closer look at the interaction between the "credit gap" and asset valuations. The issue of a "credit gap" was raised in the April edition of the IIF's CMM.

Credit gaps-the difference between a country's current credit-to-GDP ratio and the long-term trend of that ratio-can help gauge the potential duration of the current economic expansion, and may have implications for financial stability.

This month, the IIF calculates the "sset gap" and compares it with the credit gap. The asset gap is the difference of the ratio of household wealth or assets to nominal GDP from its long-term trend.

By comparing both measures, the IIF assesses the challenges monetary policymakers face in both developed and emerging economies. Generally, monetary policy is challenged when the credit gap and the asset gap move in opposite directions, indicating the need for different policy reactions.

Credit and Asset Gaps in the G7

For the G7, the two gaps have been very divergent: the credit gap of the non-financial private sector has collapsed and remained at -8 percent for some time, highlighting the broad and sustained lack of credit growth. In contrast, the asset gap of financial wealth to GDP has recovered strongly post-crisis to around +9 percent, close to its pre-crisis peak.

The implications for Euro Area monetary policy are unambiguous:the large Euro Area negative credit and total asset gaps-in addition to the lackluster recovery and persistently low inflation rates-all argue for further accommodation to stimulate the economy.

For the U.S., the implications for monetary policy are more nuanced and difficult to weigh. While the credit gap is negative, the asset gaps for both financial and total wealth are strongly positive.

The Fed faces a dilemma: to what extent should monetary policy be used to address possible signs of exuberance in asset markets for macro-prudential reasons, while the economic case for continued monetary accommodation remains valid?

Credit and Asset Gaps in Emerging Markets

For emerging market countries as a whole, the total asset gap-to-GDP ratio stands above trend, near +6 percent, while the credit gap for the non-financial private sector has reached record highs relative to trend.

The average wealth gap, however, masks significant differentiation among countries.

For China, Czech Republic, and Saudi Arabia, both positive credit and asset gaps suggestpolicymakers should tighten both monetary and prudential policies to ward off potential credit bubbles.

Korea, South Africa, Thailand, Hungary, Russia, Argentina, Turkey, Indonesia and Poland still have negative total wealth gaps, indicating thatcentral banks can gear monetary policy toward addressing economic and inflation problems.

The Institute of International Finance is the global association for the financial industry, with close to 500 members from 70 countries. Its mission is to support the financial industry in the prudent management of risks; to develop sound industry practices; and to advocate for regulatory, financial and economic policies that are in the broad interests of its members and foster global financial stability and sustainable economic growth. Within its membership IIF counts leading global banks, insurers, pension funds, asset managers and sovereign wealth funds, as well as leading law firms and consultancies. For more information visit www.iif.com.