{
  "title": "Does Financial Tranquility Call for Stringent Regulation?",
  "publication": "IMF Working Papers, May 31, 2018",
  "sourceUrl": "https://www.imf.org/en/publications/wp/issues/2018/05/31/does-financial-tranquility-call-for-stringent-regulation-45908",
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  "summary": "Consistent with the Minsky hypothesis and the “volatility paradox” (Brunnermeier and Sannikov, 2014), recent empirical evidence suggests that financial crises tend to follow prolonged periods of financial stability and investor optimism.",
  "sections": [
    {
      "heading": "Research question and approach",
      "content": "- Examines whether prolonged financial tranquility calls for increasingly stringent regulation.\n- Uses a simple portfolio choice model that features the interaction between learning and externality.\n- Evaluates the potential of a macroprudential policy to restore efficiency.\n- Characterizes the necessary and sufficient condition for the countercyclicality of the optimal regulation/macroprudential policy."
    },
    {
      "heading": "Key findings",
      "content": "- Consistent with the Minsky hypothesis and the “volatility paradox” (Brunnermeier and Sannikov, 2014), recent empirical evidence suggests financial crises tend to follow prolonged periods of financial stability and investor optimism.\n- Interaction of learning and externality in the model can generate episodes where tranquility precedes increased systemic risk.\n- The model identifies a clear condition that is necessary and sufficient for the optimal macroprudential policy to be countercyclical."
    },
    {
      "heading": "Policy implications and recommendations",
      "content": "- Policymakers should not rely solely on surface cyclical indicators (for example, credit growth); they should closely examine deep structural changes in the resilience of the financial system.\n- Macroprudential policy can potentially restore efficiency, but its design must account for learning dynamics and externalities identified in the model.\n- Importance of assigning the macroprudential policy function to independent agencies with technical expertise."
    },
    {
      "heading": "Subjects and keywords (as provided)",
      "content": "- Subjects: Economic sectors, Financial crises, Financial sector, Financial sector policy and analysis, Financial sector stability, Macroprudential policy, Systemic risk\n- Keywords: Externality, externality curve, financial crisis, Financial regulation, Financial sector, Financial sector stability, Financial stability, financial system, Global, investor confidence, investor optimism, investor risk-taking, Learning, learning process, Macroprudential, Macroprudential policy, network externality, risky asset, Systemic risk, WP\n\nIMF Working Paper — Does Financial Tranquility Call for Stringent Regulation? By Deepal Basak and Yunhui Zhao, May 31, 2018.\n\n---\n\n Content in this bundle\n\n- Does Financial Tranquility Call for Stringent Regulation?, WP/18/123, May 2018\n  - Does Financial Tranquility Call for Stringent Regulation?, WP/18/123, May 2018 (Markdown version){rel=\"alternate\" type=\"text/markdown\"}\n  - Does Financial Tranquility Call for Stringent Regulation?, WP/18/123, May 2018 (PDF){rel=\"external\" type=\"application/pdf\"}\n\n---\n\nSource: https://www.imf.org/en/publications/wp/issues/2018/05/31/does-financial-tranquility-call-for-stringent-regulation-45908"
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    "Authors: Deepal Basak, Yunhui Zhao",
    "Published: May 31, 2018",
    "Series: IMF Working Papers",
    "DOI: https://doi.org/10.5089/9781484357996.001",
    "Examines whether prolonged financial tranquility calls for increasingly stringent regulation.",
    "Uses a simple portfolio choice model that features the interaction between learning and externality.",
    "Evaluates the potential of a macroprudential policy to restore efficiency.",
    "Characterizes the necessary and sufficient condition for the countercyclicality of the optimal regulation/macroprudential policy.",
    "Consistent with the Minsky hypothesis and the “volatility paradox” (Brunnermeier and Sannikov, 2014), recent empirical evidence suggests financial crises tend to follow prolonged periods of financial stability and investor optimism.",
    "Interaction of learning and externality in the model can generate episodes where tranquility precedes increased systemic risk.",
    "The model identifies a clear condition that is necessary and sufficient for the optimal macroprudential policy to be countercyclical.",
    "Policymakers should not rely solely on surface cyclical indicators (for example, credit growth); they should closely examine deep structural changes in the resilience of the financial system.",
    "Macroprudential policy can potentially restore efficiency, but its design must account for learning dynamics and externalities identified in the model.",
    "Importance of assigning the macroprudential policy function to independent agencies with technical expertise.",
    "Subjects: Economic sectors, Financial crises, Financial sector, Financial sector policy and analysis, Financial sector stability, Macroprudential policy, Systemic risk",
    "Keywords: Externality, externality curve, financial crisis, Financial regulation, Financial sector, Financial sector stability, Financial stability, financial system, Global, investor confidence, investor optimism, investor risk-taking, Learning, learning process, Macroprudential, Macroprudential policy, network externality, risky asset, Systemic risk, WP",
    "**Does Financial Tranquility Call for Stringent Regulation?, WP/18/123, May 2018**"
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