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The Gilded Bubble Buffer

Author

Listed:
  • Xavier Freixas
  • David Perez-Reyna

Abstract

We provide a microfounded framework for the welfare analysis of macroprudential policy by means of an overlapping generation model where productivity and credit supply are subject to random shocks in order to analyze rational bubbles that can be fueled by banking credit. We find that 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 can cause systemic risk. Therefore macroprudential policy plays a key role in improving efficiency while preserving financial stability. Our approach allows us to compare the efficiency of alternative macroprudential policies. Contrarily to conventional wisdom, we show that macroprudential policy may be efficient even in the absence of systemic risk, that it has to be contingent on productivity shocks, to take into account real interest rates.

Suggested Citation

  • Xavier Freixas & David Perez-Reyna, 2018. "The Gilded Bubble Buffer," Working papers 3, Red Investigadores de Economía.
    • Handle: RePEc:rie:riecdt:3
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    More about this item

    Keywords

    Bank; bubble; macroprudential regulation;
    All these keywords.

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E60 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - General
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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