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Financial Crises and Macro-Prudential Policies

  • Gianluca Benigno
  • Huigang Chen
  • Christopher Otrok
  • Alessandro Rebucci

    ()

  • Eric Young

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). This paper studies the inefficiencies associated with borrowing decisions in a two-sector small open production economy, finding that this economy is much more likely to display under-borrowing rather than over-borrowing in normal times. As a result, macro-prudential policies (e.g, Tobin taxes or economy-wide controls on capital inflows) are costly in welfare terms. Moreover, macro-prudential policies aimed at minimizing the probability of the crisis event might be welfare-reducing in production economies. The analysis shows that there is a much larger scope for welfare gains from policy interventions during financial crises. That is to say that, ex post or crisis-management policies dominate ex ante or macro-prudential ones.

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Paper provided by Inter-American Development Bank, Research Department in its series Research Department Publications with number 4710.

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Date of creation: Feb 2011
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Handle: RePEc:idb:wpaper:4710
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  1. Gianluca Benigno & Huigang Chen & Christopher Otrok & Alessandro Rebucci & Eric Young, 2012. "Optimal Policy for Macro-Financial Stability," Research Department Publications 4818, Inter-American Development Bank, Research Department.
  2. Gianluca Benigno & Huigang Chen & Christopher Otrok & Alessandro Rebucci & Eric R. Young, 2010. "Revisiting Overborrowing and its Policy Implications," Working Papers Central Bank of Chile 582, Central Bank of Chile.
  3. Eaton, Jonathan & Gersovitz, Mark, 1981. "Debt with Potential Repudiation: Theoretical and Empirical Analysis," Review of Economic Studies, Wiley Blackwell, vol. 48(2), pages 289-309, April.
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  27. Guillermo A. Calvo & Alejandro Izquierdo & Luis Fernando Mejía, 2008. "Systemic Sudden Stops: The Relevance of Balance-Sheet Effects and Financial Integration," Research Department Publications 4581, Inter-American Development Bank, Research Department.
  28. David Backus & Patrick J. Kehoe & Finn E. Kydland, 1993. "International Business Cycles: Theory and Evidence," NBER Working Papers 4493, National Bureau of Economic Research, Inc.
  29. Christopher Otrok & Gianluca Benigno & Huigang Chen & Alessandro Rebucci & Eric R. Young, 2012. "Monetary and Macro-Prudential Policies: An Integrated Analysis," Working Papers 1208, Department of Economics, University of Missouri.
  30. Arnott, Richard & Greenwald, Bruce & Stiglitz, Joseph E., 1994. "Information and economic efficiency," Information Economics and Policy, Elsevier, vol. 6(1), pages 77-82, March.
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