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 InfoPaper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 7507.
Date of creation: Oct 2009
Date of revision:
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Other versions of this item:
- Wouter J. Den Haan & Vincent Sterk, 2011. "The Myth of Financial Innovation and the Great Moderation," Economic Journal, Royal Economic Society, vol. 121(553), pages 707-739, 06.
- 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
This paper has been announced in the following NEP Reports:
- NEP-ALL-2009-11-27 (All new papers)
- NEP-CBA-2009-11-27 (Central Banking)
- NEP-FDG-2009-11-27 (Financial Development & Growth)
- NEP-MAC-2009-11-27 (Macroeconomics)
- NEP-URE-2009-11-27 (Urban & Real Estate Economics)
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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
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"Shadow banks and macroeconomic instability,"
Temi di discussione (Economic working papers)
939, Bank of Italy, Economic Research and International Relations Area.
- Meeks, Roland & Nelson, Benjamin & Alessandri, Piergiorgio, 2014. "Shadow banks and macroeconomic instability," Bank of England working papers 487, Bank of England.
- Roland Meeks & Benjamin Nelson & Piergiorgio Alessandri, 2013. "Shadow banks and macroeconomic instability," CAMA Working Papers 2013-78, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
- 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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