Credit Spreads, Financial Crises, and Macroprudential Policy
64 Pages Posted: 2 Dec 2016 Last revised: 24 Sep 2017
Date Written: 2016-11-01
Credit spreads display occasional spikes and are more strongly countercyclical in times of financial stress. Financial crises are extreme cases of this nonlinear behavior, featuring skyrocketing credit spreads, sharp losses in bank equity, and deep recessions. We develop a macroeconomic model with a banking sector in which banks’ leverage constraints are occasionally binding and equity issuance is endogenous. The model captures the nonlinearities in the data and produces quantitatively realistic crises. Precautionary equity issuance makes crises infrequent but does not prevent them altogether. When determining the intensity of capital requirements, the macroprudential authority faces a trade-off between the benefits of reducing the risk of a financial crisis and the welfare losses associated with banks’ constrained ability to finance risky capital investments..
Keywords: financial intermediation, sudden stops, leverage constraints, occasionally binding constraints, financial stability policy
JEL Classification: E32, E44, F41
Suggested Citation: Suggested Citation