The Myth of Financial Innovation and the Great Moderation
AbstractFinancial innovation is widely believed to be at least partly responsible for the recent financial crisis. At the same time, there are empirical and theoretical arguments that support the view that changes in financial markets played a role in the "great moderation". If both are true, then the price of reducing the likelihood of another crisis, e.g., through new regulation, could be giving up another episode of sustained growth and low volatility. However, this paper questions empirical evidence supporting the view that innovation in consumer credit and home mortgages reduced cyclical variations of key economic variables. We find that especially the behaviour of aggregate home mortgages changed less during the great moderation than is typically believed. For example, aggregate home mortgages declined during monetary tightenings, both before and during the great moderation. A remarkable change we do find is that monetary tightenings became episodes during which financial institutions other than banks increased their holdings in mortgages. Once can question the desirability of such strong substitutions of ownership during economic downturns.
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Bibliographic InfoArticle provided by Royal Economic Society in its journal The Economic Journal.
Volume (Year): 121 (2011)
Issue (Month): 553 (06)
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Other versions of this item:
- Den Haan, Wouter & Sterk, Vincent, 2009. "The Myth of Financial Innovation and the Great Moderation," CEPR Discussion Papers 7507, C.E.P.R. Discussion Papers.
- E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
- E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
- G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
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Blog mentionsAs found by EconAcademics.org, the blog aggregator for Economics research:
- "The Elevated Position of the Financial Sector"
by Mark Thoma in Economist's View on 2011-10-27 07:24:00
- "The Elevated Position of the Financial Sector"
by Economists View in FavStocks on 2011-10-28 10:02:14
- Grydaki, Maria & Bezemer, Dirk, 2013. "The role of credit in the Great Moderation: A multivariate GARCH approach," Journal of Banking & Finance, Elsevier, vol. 37(11), pages 4615-4626.
- Gaetano Antinolfi & Celso Brunetti, 2013. "Economic volatility and financial markets: the case of mortgage-backed securities," Finance and Economics Discussion Series 2013-42, Board of Governors of the Federal Reserve System (U.S.).
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