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Financial cycles, credit bubbles and stabilization policies

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  • Schuler, Tobias
  • Corrado, Luisa

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. JEL Classification: E44, E52

Suggested Citation

  • Schuler, Tobias & Corrado, Luisa, 2019. "Financial cycles, credit bubbles and stabilization policies," Working Paper Series 2336, European Central Bank.
    • Handle: RePEc:ecb:ecbwps:20192336
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    Cited by:

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    3. 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.
    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, February.

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    More about this item

    Keywords

    Basel III; CCyB; credit-to-GDP gap;
    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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