The Gilded Bubble Buffer and Optimal Macroprudential Policy

46 Pages Posted: 1 Jan 2020

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: November 7, 2019

Abstract

We provide a microfounded framework for the welfare analysis of macroprudential policy within a model of rational bubbles. For this we posit an overlapping generation model where productivity and credit supply are subject to random shocks. We find that when real interest rates are lower than the rate of growth, credit financed bubbles may be welfare improving because of their role as a buffer in channeling excessive credit supply and inefficient investment at the firms' level, but its sudden price decrease may cause a systemic crisis. Therefore a well designed macroprudential policy plays a key role in improving efficiency while preserving financial stability. Our theoretical framework allows us to compare the efficiency of alternative macroprudential policies. Contrarily to conventional wisdom, we show that (i) macroprudential policy may be efficient even in the absence of systemic risk, (ii) it has to be contingent on productivity shocks and (iii) it must be contingent upon the level of real interest rates.

Keywords: Bank, bubble, macroprudential regulation

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

Suggested Citation

Freixas, Xavier and Perez-Reyna, David, The Gilded Bubble Buffer and Optimal Macroprudential Policy (November 7, 2019). Available at SSRN: https://ssrn.com/abstract=3503660 or http://dx.doi.org/10.2139/ssrn.3503660

Xavier Freixas

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 (Contact Author)

Universidad de los Andes, Colombia ( email )

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

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