Financial Crisis and Macro-Prudential Policies

53 Pages Posted: 18 Jan 2011

See all articles by Gianluca Benigno

Gianluca Benigno

London School of Economics & Political Science (LSE) - Department of Economics; Federal Reserve Bank of New York

Huigang Chen

International Monetary Fund (IMF)

Chris Otrok

University of Missouri; Federal Reserve Banks - Federal Reserve Bank of St. Louis

Alessandro Rebucci

Johns Hopkins University - Carey Business School; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Eric R. Young

University of Virginia

Multiple version iconThere are 2 versions of this paper

Date Written: January 2011

Abstract

Stochastic general equilibrium models of small open economies with occasionally binding financial frictions are capable of mimicking both the business cycles and the crisis events associated with the sudden stop in access to credit markets (Mendoza, 2010). In this paper we study the inefficiencies associated with borrowing decisions in a two-sector small open production economy. We find that this economy is much more likely to display "under-borrowing" rather than "over-borrowing" in normal times. As a result, macro-prudential policies (i.e. Tobin taxes or economy-wide controls on capital inflows) are costly in welfare terms in our economy. Moreover, we show that macro-prudential policies aimed at minimizing the probability of the crisis event might be welfare-reducing. Our analysis shows that there is a much larger scope for welfare gains from policy interventions during financial crises. That is to say that, within our modelling approach, ex post or crisis-management policies dominate ex ante or macro-prudential ones.

Keywords: Bailouts, Capital Controls, Crises, Financial Frictions, Macro Prudential Policies, Overborrowing

JEL Classification: E52, F37, F41

Suggested Citation

Benigno, Gianluca and Benigno, Gianluca and Chen, Huigang and Otrok, Christopher and Rebucci, Alessandro and Young, Eric R., Financial Crisis and Macro-Prudential Policies (January 2011). CEPR Discussion Paper No. DP8175, Available at SSRN: https://ssrn.com/abstract=1742700

Gianluca Benigno (Contact Author)

London School of Economics & Political Science (LSE) - Department of Economics ( email )

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Federal Reserve Bank of New York ( email )

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Huigang Chen

International Monetary Fund (IMF) ( email )

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Christopher Otrok

University of Missouri ( email )

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Alessandro Rebucci

Johns Hopkins University - Carey Business School ( email )

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National Bureau of Economic Research (NBER) ( email )

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Centre for Economic Policy Research (CEPR) ( email )

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Eric R. Young

University of Virginia ( email )

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