Optimal macroprudential policy and rational bubbles |
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| Institution: | 1. Professor at Universitat Pompeu Fabra, Barcelona Graduate School of Economics and CEPR, Ramon Trias Fargas, 25-27 08005 Barcelona, Spain;2. Associate professor at Universidad de los Andes. Calle 19A No 1-37 Este, Bloque W, Bogotá, 111711, Colombia;1. D’Amore-McKim School of Business, Northeastern University, USA;2. Olin Business School, Washington University in St. Louis, USA;1. Bank of Canada, 234 Wellington St, Ottawa, ON K1A 0G9, Canada;2. Centre for Economic Policy Research, London, United Kingdom;1. Banco de Portugal, Economics and Research Department, Av, Almirante Reis 71, 1150-015 Lisbon, Portugal;1. London School of Economics and Political Science, Centre for Economic Policy Research (CEPR), and European Corporate Governance Institute (ECGI), Houghton Street, London WC2A 2AE, United Kingdom;2. London School of Economics and Political Science and European Corporate Governance Institute (ECGI);3. Centre for Economic Performance (CEP) and Copenhagen Business School, Frederiksberg, Denmark;4. London School of Economics and Political Science, Houghton Street, London WC2A 2AE, United Kingdom;1. EDHEC Business School;2. Department of Finance, BI Norwegian Business School, Nydalsveien 37, Oslo NO-0387, Norway;3. Independent;4. Department of Finance and Center for Financial Frictions (FRIC), Copenhagen Business School, Solbjerg Plads 3, Frederiksberg DK-2000, Denmark |
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| Abstract: | We provide a microfounded framework for the welfare analysis of macroprudential policy within a model of rational bubbles. For this, we posit an overlapping generation model where productivity and credit supply are subject to random shocks. We find that when real interest rates are lower than the rate of growth, credit financed bubbles may be welfare improving because of their role as a buffer in channeling excessive credit supply and inefficient investment at the firms’ level, but their sudden price decrease may cause a systemic crisis. Therefore, a well designed macroprudential policy plays a key role in improving efficiency while preserving financial stability. Our theoretical framework allows us to compare the efficiency of alternative macroprudential policies. Contrarily to conventional wisdom, we show that macroprudential policy (i) may be efficient even in the absence of systemic risk, (ii) has to be contingent on productivity shocks and (iii) must be contingent upon the level of real interest rates. |
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