Financial Cycles, Credit Bubbles and Stabilization Policies

44 Pages Posted: 4 Dec 2019

See all articles by Tobias Schuler

Tobias Schuler

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

Luisa Corrado

University of Rome Tor Vergata Department of Economics and Finance

Multiple version iconThere are 2 versions of this paper

Date Written: December, 2019

Abstract

This paper analyzes the effects of several policy instruments for mitigating financial bubbles generated in the banking sector. We augment a New Keynesian macroeconomic framework by endogenizing boundedly-rational expectations on asset values of loan portfolios, allow for interbank trading and show how a credit bubble can develop from a financial innovation. We then evaluate the efficacy of several policy instruments in counteracting financial bubbles. We find that an endogenous capital requirement reduces the impact of a financial bubble significantly while central bank intervention (“leaning against the wind”) proves to be less effective. A welfare analysis ranks the policy reaction through an endogenous capital requirement highest. We therefore provide a rationale for the use of countercyclical capital buffers.

Keywords: Basel III, CCyB, credit-to-GDP gap

JEL Classification: E44, E52

Suggested Citation

Schuler, Tobias and Corrado, Luisa, Financial Cycles, Credit Bubbles and Stabilization Policies (December, 2019). ECB Working Paper No. 2336, Available at SSRN: https://ssrn.com/abstract=3497525

Tobias Schuler (Contact Author)

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

Poschinger Str. 5
Munich, 01069
Germany

Luisa Corrado

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

Via Columbia n.2
Rome, rome 00100
Italy

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