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Financial Crisis and Macro-Prudential Policies

Author

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  • Benigno, Gianluca
  • Chen, Huigang
  • Otrok, Christopher
  • Rebucci, Alessandro
  • Young, Eric R

Abstract

Stochastic general equilibrium models of small open economies with occasionally binding financial frictions are capable of mimicking both the business cycles and the crisis events associated with the sudden stop in access to credit markets (Mendoza, 2010). In this paper we study the inefficiencies associated with borrowing decisions in a two-sector small open production economy. We find that this economy is much more likely to display "under-borrowing" rather than "over-borrowing" in normal times. As a result, macro-prudential policies (i.e. Tobin taxes or economy-wide controls on capital inflows) are costly in welfare terms in our economy. Moreover, we show that macro-prudential policies aimed at minimizing the probability of the crisis event might be welfare-reducing. Our analysis shows that there is a much larger scope for welfare gains from policy interventions during financial crises. That is to say that, within our modelling approach, ex post or crisis-management policies dominate ex ante or macro-prudential ones.

Suggested Citation

  • Benigno, Gianluca & Chen, Huigang & Otrok, Christopher & Rebucci, Alessandro & Young, Eric R, 2011. "Financial Crisis and Macro-Prudential Policies," CEPR Discussion Papers 8175, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:8175
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    More about this item

    Keywords

    Bailouts; Capital Controls; Crises; Financial Frictions; Macro Prudential Policies; Overborrowing;
    All these keywords.

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • F37 - International Economics - - International Finance - - - International Finance Forecasting and Simulation: Models and Applications
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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