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Managing Credit Bubbles

Author

Listed:
  • Alberto Martín
  • Jaume Ventura

Abstract

We study a dynamic economy where credit is limited by insufficient collateral and, as a result, investment and output are too low. In this environment, changes in investor sentiment or market expectations can give rise to credit bubbles, that is, expansions in credit that are backed not by expectations of future profits (i.e. fundamental collateral), but instead by expectations of future credit (i.e. bubbly collateral). Credit bubbles raise the availability of credit for entrepreneurs: this is the crowding-in effect. But entrepreneurs must also use some of this credit to cancel past credit: this is the crowding-out effect. There is an "optimal" bubble size that trades off these two effects and maximizes long-run output and consumption. The equilibrium bubble size depends on investor sentiment, however, and it typically does not coincide with the "optimal" bubble size. This provides a new rationale for macroprudential policy. A credit management agency (CMA) can replicate the "optimal" bubble by taxing credit when the equilibrium bubble is too high and subsidizing credit when the equilibrium bubble is too low. This leaning-against-the-wind policy maximizes output and consumption. Moreover, the same conditions that make this policy desirable guarantee that a CMA has the resources to implement it.

Suggested Citation

  • Alberto Martín & Jaume Ventura, 2015. "Managing Credit Bubbles," Working Papers 823, Barcelona Graduate School of Economics.
  • Handle: RePEc:bge:wpaper:823
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    References listed on IDEAS

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    1. Stijn Claessens & M. Ayhan Kose & Marco E. Terrones, 2011. "Financial Cycles: What? How? When?," NBER International Seminar on Macroeconomics, University of Chicago Press, vol. 7(1), pages 303-344.
    2. Caballero, Ricardo J. & Krishnamurthy, Arvind, 2006. "Bubbles and capital flow volatility: Causes and risk management," Journal of Monetary Economics, Elsevier, vol. 53(1), pages 35-53, January.
    3. Aoki, Kosuke & Nikolov, Kalin, 2015. "Bubbles, banks and financial stability," Journal of Monetary Economics, Elsevier, vol. 74(C), pages 33-51.
    4. Bas B. Bakker & Giovanni Dell'Ariccia & Luc Laeven & Jérôme Vandenbussche & Deniz O Igan & Hui Tong, 2012. "Policies for Macrofinancial Stability; How to Deal with Credit Booms," IMF Staff Discussion Notes 12/06, International Monetary Fund.
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    Citations

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    Cited by:

    1. Galip Kemal Ozhan, 2015. "Financial Intermediation, Resource Allocation, and Macroeconomic Interdependence," 2015 Papers poz71, Job Market Papers.
    2. repec:eee:macchp:v2-1427 is not listed on IDEAS
    3. Hanson, Andrew & Phan, Toan, 2017. "Bubbles, wage rigidity, and persistent slumps," Economics Letters, Elsevier, vol. 151(C), pages 66-70.
    4. Alberto Martin & Jaume Ventura, 2017. "The macroeconomics of rational bubbles: a user's guide," Economics Working Papers 1581, Department of Economics and Business, Universitat Pompeu Fabra.
    5. repec:pal:compes:v:60:y:2018:i:1:d:10.1057_s41294-018-0054-8 is not listed on IDEAS
    6. Martin, Alberto & Ventura, Jaume, 2015. "The international transmission of credit bubbles: Theory and policy," Journal of Monetary Economics, Elsevier, vol. 76(S), pages 37-56.
    7. Xavier Raurich & Thomas Seegmuller, 2017. "Income Distribution by Age Group and Productive Bubbles," AMSE Working Papers 1740, Aix-Marseille School of Economics, Marseille, France.
    8. Luh, Yir-Hueih & Jiang, Wun-Ji & Huang, Szu-Chi, 2016. "Trade-related spillovers and industrial competitiveness: Exploring the linkages for OECD countries," Economic Modelling, Elsevier, vol. 54(C), pages 309-325.
    9. Stefano Giglio & Matteo Maggiori & Johannes Stroebel, 2016. "No‐Bubble Condition: Model‐Free Tests in Housing Markets," Econometrica, Econometric Society, vol. 84, pages 1047-1091, May.
    10. Fabrizio Perri & Jonathan Heathcote, 2011. "Wealth and Volatility," 2011 Meeting Papers 1065, Society for Economic Dynamics.
    11. repec:eee:jbfina:v:89:y:2018:i:c:p:78-93 is not listed on IDEAS
    12. Bengui, Julien & Phan, Toan, 2018. "Asset Pledgeability and Endogenously Leveraged Bubbles," Working Paper 18-11, Federal Reserve Bank of Richmond.
    13. Tripathy, Jagdish, 2017. "Bubbly equilibria with credit misallocation," Bank of England working papers 649, Bank of England.
    14. Mathieu Boullot, 2017. "Secular Stagnation, Liquidity Trap and Rational Asset Price Bubbles," Working Papers halshs-01295012, HAL.
    15. Vorada Limjaroenrat, 2017. "Distributional Effects of Monetary Policy on Housing Bubbles: Some Evidence," PIER Discussion Papers 74, Puey Ungphakorn Institute for Economic Research, revised Oct 2017.

    More about this item

    Keywords

    Bubbles; credit; Business cycles; economic growth; financial frictions; pyramid schemes;

    JEL classification:

    • 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
    • O40 - Economic Development, Innovation, Technological Change, and Growth - - Economic Growth and Aggregate Productivity - - - General

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