Advertisement

IMF Economic Review

, Volume 60, Issue 2, pp 223–269 | Cite as

Macroprudential Policy in a Fisherian Model of Financial Innovation

  • Javier Bianchi
  • Emine Boz
  • Enrique Gabriel Mendoza
Article

Abstract

The interaction between credit frictions, financial innovation, and a switch from optimistic to pessimistic beliefs played a central role in the 2008 financial crisis. This paper develops a quantitative general equilibrium framework in which this interaction drives the financial amplification mechanism to study the effects of macroprudential policy. Financial innovation enhances the ability of agents to collateralize assets into debt, but the riskiness of this new regime can only be learned over time. Beliefs about transition probabilities across states with high and low ability to borrow change as agents learn from observed realizations of financial conditions. At the same time, the collateral constraint introduces a pecuniary externality, because agents fail to internalize the effect of their borrowing decisions on asset prices. Quantitative analysis shows that the effectiveness of macroprudential policy in this environment depends on the government's information set, the tightness of credit constraints, and the pace at which optimism surges in the early stages of financial innovation. The policy is least effective when the government is as uninformed as private agents, credit constraints are tight, and optimism builds quickly.

JEL Classifications

D62 D82 E32 E44 F32 F41 

References

  1. Aiyagari, R., and M. Gertler, 1999, “Overreaction of Asset Prices in General Equilibrium,” Review of Economic Dynamics, Vol. 2, No. 1, pp. 3–35.CrossRefGoogle Scholar
  2. Benigno, G., others 2010, “Financial Crises and Macro-Prudential Policy,” mimeo, University of Virginia.Google Scholar
  3. Bernanke, B., M. Gertler, and S. Gilchrist, 1999, “The Financial Accelerator in a Quantitative Business Cycle Model,” in Handbook of Macroeconomics, Vol. 1C, ed. by J. Taylor and M. Woodford (Amsterdam: North-Holland).Google Scholar
  4. Bianchi, J., 2011, “Overborrowing and Systemic Externalities in the Business Cycle,” American Economic Review, Vol. 101, No. 7, pp. 3400–3426.CrossRefGoogle Scholar
  5. Bianchi, J., and E.G. Mendoza, 2010, “Overborrowing, Financial Crises and ‘Macroprudential’ Policy,” NBER Working Paper No. 16091.Google Scholar
  6. Boz, E., and E.G. Mendoza, 2010, “Financial Innovation, the Discovery of Risk, and the U.S. Credit Crisis,” NBER Working Paper 16020.Google Scholar
  7. Cao, D., 2011, “Collateral Shortages, Asset Price and Investment Volatility with Heterogeneous Beliefs,” mimeo, Georgetown University.Google Scholar
  8. Cogley, T., and T. Sargent, 2008a, “The Market Price of Risk and the Equity Premium: A Legacy of the Great Depression?” Journal of Monetary Economics, Vol. 55, No. 3, pp. 454–476.CrossRefGoogle Scholar
  9. Cogley, T., and T.J. Sargent, 2008b, “Anticipated Utility and Rational Expectations as Approximations of Bayesian Decision Making,” International Economic Review, Vol. 49, No. 1, pp. 185–221.CrossRefGoogle Scholar
  10. Davis, M., and J. Heathcote, 2007, “The Price and Quantity of Residential Land in the United States,” Journal of Monetary Economics, Vol. 54, No. 8, pp. 2595–2620.CrossRefGoogle Scholar
  11. Fisher, I., 1933, “The Debt-Deflation Theory of Great Depressions,” Econometrica, Vol. 1, No. 4, pp. 337–357.CrossRefGoogle Scholar
  12. Geanakoplos, J., 2010, “The Leverage Cycle,” in NBER Macro-Economics Annual 2009, ed. by D. Acemoglu, K. Rogoff, and M. Woodford (Chicago: University of Chicago Press).Google Scholar
  13. Gennaioli, N., and A. Shleifer, 2010, “What Comes to Mind,” The Quarterly Journal of Economics, Vol. 125, No. 4, pp. 1399–1433.CrossRefGoogle Scholar
  14. Gennaioli, N., A. Shleifer, and R. Vishny, 2012, “Neglected Risks, Financial Innovation, and Financial Fragility,” Journal of Financial Economics, Vol. 104, No. 3, pp. 452–468.CrossRefGoogle Scholar
  15. Jeanne, O., and A. Korinek, 2010, “Managing Credit Booms and Busts: A Pigouvian Taxation Approach,” Discussion paper, NBER Working Paper.Google Scholar
  16. Kehoe, T.J., and D. Levine, 1993, “Debt-Constrained Asset Markets,” Review of Economic Studies, Vol. 60, No. 4, pp. 865–888.CrossRefGoogle Scholar
  17. Kiyotaki, N., and J. Moore, 1997, “Credit Cycles,” Journal of Political Economy, Vol. 105, No. 2, pp. 211–248.CrossRefGoogle Scholar
  18. Korinek, A., 2010, “Systemic Risk-Taking: Accelerator Effects, Externalities, and Regulatory,” mimeo, University of Maryland.Google Scholar
  19. Lorenzoni, G., 2008, “Inefficient Credit Booms,” Review of Economic Studies, Vol. 75, No. 3, pp. 809–833.CrossRefGoogle Scholar
  20. Lustig, H., 2000, “Secured Lending and Asset Prices,” mimeo, Stanford University.Google Scholar
  21. Mendoza, E.G., and M.E. Terrones, 2008, “An Anatomy of Credit Booms: Evidence from Macro Aggregates and Micro Data,” NBER Working Paper 14049.Google Scholar
  22. Minsky, H., 1992, “The Financial Instability Hypothesis,” The Jerome Levy Economics Institute Working Paper No. 74.Google Scholar
  23. Simsek, A., 2010, “Belief Disagreements and Collateral Constraints,” mimeo, Harvard University.Google Scholar
  24. Stein, J., 2011, “Monetary Policy as Financial-Stability Regulation,” Discussion paper, NBER Working Paper.Google Scholar

Copyright information

© International Monetary Fund 2012

Authors and Affiliations

  • Javier Bianchi
  • Emine Boz
  • Enrique Gabriel Mendoza

There are no affiliations available

Personalised recommendations