Credit Spreads, Financial Crises, and Macroprudential Policy

64 Pages Posted: 2 Dec 2016 Last revised: 24 Sep 2017

See all articles by Ozge Akinci

Ozge Akinci

Federal Reserve Bank of New York

Albert Queralto

Federal Reserve Board - Trade and Financial Studies Section

Date Written: 2016-11-01

Abstract

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

Akinci, Ozge and Queralto, Albert, Credit Spreads, Financial Crises, and Macroprudential Policy (2016-11-01). FRB of NY Staff Report No. 802. Available at SSRN: https://ssrn.com/abstract=2879279

Ozge Akinci (Contact Author)

Federal Reserve Bank of New York ( email )

New York, NY 10045
United States

Albert Queralto

Federal Reserve Board - Trade and Financial Studies Section ( email )

20th St. and Constitution Ave.
Washington, DC 20551
United States

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