Financial Bubbles in Interbank Lending

34 Pages Posted: 9 Apr 2018

See all articles by Luisa Corrado

Luisa Corrado

University of Rome Tor Vergata Department of Economics and Finance

Tobias Schuler

CESifo (Center for Economic Studies and Ifo Institute) - Ifo Institute

Date Written: April 6, 2018

Abstract

As a result of the global financial crisis countercyclical capital requirements have been discussed to prevent fi nancial bubbles generated in the banking sector and to mitigate the adverse effects of fi nancial repression after a bubble burst. This paper analyses the effects of an endogenous capital requirement based on the credit-to-GDP gap along with other policy instruments. We develop a macroeconomic framework which endogenizes market expectations on asset values and allows for interbank transactions. We then show how a bubble in the banking sector relaxes fi nancing constraints. In policy experiments we find that an endogenous capital requirement can effectively reduce the impact of a financial bubble. We show that central bank intervention ("leaning against the wind") instead has only a minor effect.

Keywords: Financial bubbles, credit-to-GDP gap, endogenous capital requirement, stabilization policies

JEL Classification: E44, E52

Suggested Citation

Corrado, Luisa and Schuler, Tobias, Financial Bubbles in Interbank Lending (April 6, 2018). CEIS Working Paper No. 427. Available at SSRN: https://ssrn.com/abstract=3157730 or http://dx.doi.org/10.2139/ssrn.3157730

Luisa Corrado (Contact Author)

University of Rome Tor Vergata Department of Economics and Finance ( email )

Via Columbia n.2
Rome, rome 00100
Italy

Tobias Schuler

CESifo (Center for Economic Studies and Ifo Institute) - Ifo Institute ( email )

Poschinger Str. 5
Munich, 01069
Germany

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