The Good, the Bad and the Missed Boom
Tinbergen Institute Discussion Paper 2019-060/IV
53 Pages Posted: 22 Aug 2019 Last revised: 26 May 2020
Date Written: June 28, 2019
Some credit booms result in financial crises. While excessive risk-taking is a plausible cause, many investors do not anticipate increasing risk. We show how credit supply driven booms may be misunderstood as productivity driven, due to opaque bank balance sheets which disguise risk incentives. Funding shocks may sustain prudent lending (good boom), induce high risk exposure and boost asset prices (bad boom), or lead to underlending (missed boom). Rational agents drawing inference from prices amplify the effect of excess or scarce funding. Public information on total credit improves inference, but cannot avoid confusion when bank opacity is high.
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