Macroprudential Policy with Learning from Credit Spreads and Misperception

71 Pages Posted: 21 Nov 2022 Last revised: 16 Apr 2024

See all articles by Yeow Hwee Chua

Yeow Hwee Chua

Nanyang Technological University (NTU)

Zu Yao Hong

The University of Nottingham Ningbo, China

Date Written: October 29, 2022

Abstract

This paper examines how information frictions affect the conduct of macroprudential policy. Since macroprudential policy directly influences credit prices, it can impact beliefs when agents learn from credit spreads and experience policy misperception. We show that when agents do not accurately internalize and account for the policy effects on credit spreads, they mistakenly attribute changes in credit prices to the aggregate state. Consequently, agents erroneously update their beliefs about the aggregate state, even when the underlying aggregate state remains unchanged. Our findings suggest that instead of correcting externalities with policies, externalities can arise due to policy actions. The optimal policy adjustments depend on whether policy misperception and learning from credit spreads amplify or dampen the initial policy effect. To prevent sub-optimal outcomes, we highlight the importance of clear central bank communication.

Keywords: Credit Cycles, Macroprudential Policies, Information Frictions, Financial Stability, Learning from Credit Spreads, Misperception, Central Bank Communication

JEL Classification: E32, E44, G1, G12

Suggested Citation

Chua, Yeow Hwee and Hong, Zu Yao, Macroprudential Policy with Learning from Credit Spreads and Misperception (October 29, 2022). Available at SSRN: https://ssrn.com/abstract=4262100 or http://dx.doi.org/10.2139/ssrn.4262100

Yeow Hwee Chua (Contact Author)

Nanyang Technological University (NTU) ( email )

Singapore
Singapore

Zu Yao Hong

The University of Nottingham Ningbo, China ( email )

199 Taikang East Road
Ningbo, Zhejiang 315100
China

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