The Gilded Bubble Buffer

40 Pages Posted: 12 Nov 2017

See all articles by Xavier Freixas

Xavier Freixas

Universitat Pompeu Fabra; Centre for Economic Policy Research (CEPR); Barcelona Graduate School of Economics (Barcelona GSE)

David Perez-Reyna

Universidad de los Andes, Colombia

Date Written: October 19, 2017

Abstract

Excessive credit growth and high asset prices increase systemic risks. Because, in equilibrium, these two variables are jointly determined the analysis of systemic risk and the cost-benefit analysis of macroprudential regulation require a specific framework consistent with the existing empirical evidence. We argue that an overlapping generation model of rational bubbles can explain some of the main features of banking crises, thus providing a microfounded framework for the rigorous analysis of macroprudential policy. We find that credit financed bubbles may have a role as a buffer in channeling excessive credit supply and inefficient investment at the firms’ level. Still, when banks have a risk of going bankrupt a trade-off appears between financial stability and efficiency. When this is the case, macroprudential policy has a key role in improving efficiency while preserving financial stability. Contrarily to common regulatory views, the one size fits all approach where a countercyclical buffer is implemented to counteract an excessive increase in credit growth, the optimal macroprudential policy has to take into account the origin of the shock. As wages, liquidity and productivity shocks determine the equilibrium level of credit, it is not surprising that the optimal macroprudential policy has to adapt to each type of shock.

Keywords: Banks, Bubbles, Macroprudential Regulation

JEL Classification: E44, E60, G18, G21, G28

Suggested Citation

Freixas, Xavier and Perez-Reyna, David, The Gilded Bubble Buffer (October 19, 2017). Documento CEDE No. 2017-58. Available at SSRN: https://ssrn.com/abstract=3069035 or http://dx.doi.org/10.2139/ssrn.3069035

Xavier Freixas (Contact Author)

Universitat Pompeu Fabra ( email )

Ramon Trias Fargas 25-27
Barcelona, 08005
Spain
+34 93 542 2726 (Phone)
+34 93 542 1746 (Fax)

HOME PAGE: http://www.econ.upf.es/~freixas

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

HOME PAGE: http://www.econ.upf.es/~freixas/more/personal1.htm

Barcelona Graduate School of Economics (Barcelona GSE) ( email )

Ramon Trias Fargas, 25-27
Barcelona, Barcelona 08005
Spain

David Perez-Reyna

Universidad de los Andes, Colombia ( email )

Carrera Primera # 18A-12
Bogota, DC D.C. 110311
Colombia

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