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Author/Editor:
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Bianchi, Javier ; Boz, Emine ; Mendoza, Enrique G.
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Publication Date:
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July 01, 2012
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Electronic Access:
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Free Full text
(PDF file size is 1,548KB).
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Disclaimer: This Working Paper should not be reported as representing the views of the IMF.
The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate
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Summary:
The interaction between credit frictions, financial innovation, and a switch from optimistic to
pessimistic beliefs played a central role in the 2008 financial crisis. This paper develops a
quantitative general equilibrium framework in which this interaction drives the financial
amplification mechanism to study the effects of macro-prudential policy. Financial innovation
enhances the ability of agents to collateralize assets into debt, but the riskiness of this new regime
can only be learned over time. Beliefs about transition probabilities across states with high and low
ability to borrow change as agents learn from observed realizations of financial conditions. At the
same time, the collateral constraint introduces a pecuniary externality, because agents fail to
internalize the effect of their borrowing decisions on asset prices. Quantitative analysis shows that
the effectiveness of macro-prudential policy in this environment depends on the government's
information set, the tightness of credit constraints and the pace at which optimism surges in the
early stages of financial innovation. The policy is least effective when the government is as
uninformed as private agents, credit constraints are tight, and optimism builds quickly.
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Order a print copy
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Series:
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Working Paper No. 12/181
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Subject(s):
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Economic models | Financial crisis | Macroprudential policy
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Author's Keyword(s):
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Financial crises | financial innovation | macro-prudential regulation | Bayesian learning |
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English
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Publication Date:
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July 01, 2012
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Format:
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Paper
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Stock No:
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WPIEA2012181
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Pages:
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53
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Price:
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US$18.00 )
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Please address any questions about this title to
publications@imf.org
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