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Financial Cycles, Credit Bubbles and Stabilization Policies

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  • Luisa Corrado
  • Tobias Schuler

Abstract

This paper analyzes the effects of several policy instruments to mitigate 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 and allow for interbank trading. We then show how a financial bubble can develop from a financial innovation. By incorporating a loan management technology and a bank equity channel we can 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 as best.

Suggested Citation

  • Luisa Corrado & Tobias Schuler, 2018. "Financial Cycles, Credit Bubbles and Stabilization Policies," CESifo Working Paper Series 7422, CESifo.
    • Handle: RePEc:ces:ceswps:_7422
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    Cited by:

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    2. Gulan, Adam & Jokivuolle, Esa & Verona, Fabio, 2022. "Optimal bank capital requirements: What do the macroeconomic models say?," BoF Economics Review 2/2022, Bank of Finland.
    3. Wang, Miao & Wang, Wenfu, 2024. "Government debt and stock bubbles in China," Economic Modelling, Elsevier, vol. 141(C).
    4. Júlia Király, 2020. "Hungary and Other Emerging EU Countries in the Financial Storm," Financial and Monetary Policy Studies, Springer, number 978-3-030-49544-2, September.
    5. repec:cnb:ocpubc:geo2020/7 is not listed on IDEAS

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    More about this item

    Keywords

    financial bubbles; credit-to-GDP gap; endogenous capital requirement; stabilization policies;
    All these keywords.

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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