The Myth of Financial Innovation and the Great Moderation
Financial 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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- Urban Jermann & Vincenzo Quadrini, 2006.
"Financial Innovations and Macroeconomic Volatility,"
NBER Working Papers
12308, National Bureau of Economic Research, Inc.
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2011/04, Economics Department, Universitat Jaume I, Castellón (Spain).
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- Matteo Iacoviello & Marina Pavan, 2011. "Housing and debt over the life cycle and over the business cycle," International Finance Discussion Papers 1032, Board of Governors of the Federal Reserve System (U.S.).
- Matteo Iacoviello & Marina Pavan, 2009. "Housing and Debt Over the Life Cycle and Over the Business Cycle," Boston College Working Papers in Economics 723, Boston College Department of Economics, revised 19 Sep 2011.
- Matteo Iacoviello & Marina Pavan, 2009. "Housing and debt over the life cycle and over the business cycle," Working Papers 09-12, Federal Reserve Bank of Boston.
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"Assessing the Sources of Changes in the Volatility of Real Growth,"
RBA Annual Conference Volume,
in: Christopher Kent & David Norman (ed.), The Changing Nature of the Business Cycle
Reserve Bank of Australia.
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