The Volatility Costs of Procyclical Lending Standards: An Assessment Using a Dsge Model

March 1, 2009

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Silvia Sgherri, and Bertrand Gruss. The Volatility Costs of Procyclical Lending Standards: An Assessment Using a Dsge Model, (USA: International Monetary Fund, 2009) accessed November 8, 2024

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

Summary

The ongoing financial turmoil has triggered a lively debate on ways of containing systemic risk and lessening the likelihood of boom-and-bust episodes in credit markets. Particularly, it has been argued that banking regulation might attenuate procyclicality in lending standards by affecting the behavior of banks’ capital buffers. This paper uses a two-country DSGE model with financial frictions to illustrate how procyclicality in borrowing limits reinforces the “overreaction” of asset prices to shocks described by Aiyagari and Gertler (1999), and to quantify the stabilization gains from policies aimed at smoothing cyclical swings in credit conditions. Results suggest that, in financially constrained economies, the ensuing volatility reduction in equity prices, investment, and external imbalances would be sizable. In the presence of cross-border spillovers, gains would be even higher.

Subject: Asset prices, Collateral, Consumption, Credit, Financial institutions, Money, National accounts, Prices, Stocks

Keywords: Asset prices, Baltics, Business cycle, Collateral, Collateral Constraints, Consumption, Credit, Credit Cycles, Credit squeeze, DSGE Models., Equity premium, Equity price, Home economy, Lending standard, LTV ratio, Stocks, Western Europe, WP

Publication Details

Pages:

37
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2009/035
Stock No:

WPIEA2009035
ISBN:

9781451871821
ISSN:

1018-5941

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