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The Gilded Bubble Buffer

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  • Xavier Freixas
  • David Perez-Reyna

Abstract

Excessive credit growth and high asset prices increase systemic risks. Because, in equilibrium, these two variables are jointly determined the analysis of systemic risk and the cost-benefit analysis of macroprudential regulation require a specific frame- work consistent with the existing empirical evidence. We argue that an overlapping generation model of rational bubbles can explain some of the main features of banking crises, thus providing a microfounded framework for the rigorous analysis of macro-prudential policy. We find that credit financed bubbles may have a role as a buffer in channeling excessive credit supply and inefficient investment at the firms' level. Still, when banks have a risk of going bankrupt a trade-o_ appears between financial stability and efficiency. When this is the case, macroprudential policy has a key role in improv-ing efficiency while preserving financial stability. Contrarily to common regulatory views, the one size fits all approach where a countercyclical buffer is implemented to counteract an excessive increase in credit growth, the optimal macroprudential policy has to take into account the origin of the shock. As wages, liquidity and productivity shocks determine the equilibrium level of credit, it is not surprising that the optimal macroprudential policy has to adapt to each type of shock.

Suggested Citation

  • Xavier Freixas & David Perez-Reyna, 2017. "The Gilded Bubble Buffer," Documentos CEDE 15789, Universidad de los Andes, Facultad de Economía, CEDE.
  • Handle: RePEc:col:000089:015789
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    More about this item

    Keywords

    Banks; bubbles; macroprudential regulation;
    All these keywords.

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E60 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - General
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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