European Parliament Library

Managing Credit Bubbles, Alberto Martin, Jaume Ventura

We study a dynamic economy where credit is limited by insufficient collateral and, as a result, investment and output are too low. In this environment, changes in investor sentiment or market expectations can give rise to credit bubbles, that is, expansions in credit that are backed not by expectations of future profits (i.e. fundamental collateral), but instead by expectations of future credit (i.e. bubbly collateral). During a credit bubble, there is more credit available for entrepreneurs: this is the crowding-in effect. But entrepreneurs must also use some of this credit to cancel past credit: this is the crowding-out effect. There is an "optimal" bubble size that trades off these two effects and maximizes long-run output and consumption. The “equilibrium” bubble size depends on investor sentiment, however, and it typically does not coincide with the “optimal” bubble size. This provides a new rationale for macroprudential policy. A lender of last resort can replicate the “optimal” bubble by taxing credit when the "equilibrium" bubble is too high, and subsidizing credit when the “equilibrium” bubble is too low. This leaning-against-the-wind policy maximizes output and consumption. Moreover, the same conditions that make this policy desirable guarantee that a lender of last resort has the resources to implement it
Table Of Contents
Cover; Contents; 1 The bubbly economy; 1.1 The basic setup; 1.2 Markets and prices; 1.3 Equilibrium dynamics; 2 Bubbly equilibria; 2.1 Bubbly business cycles; 2.2 Bubbly and real business cycles; 3 A lender of last resort; 3.1 Themodel with a lender of last resort; 3.2 Equilibrium dynamics; 3.3 Managing collateral during business cycles; 4 The fiscal backstop; 4.1 The model with debt; 4.2 Equilibrium dynamics; 4.3 Are there limits to debt financing?; 5 On the size and type of bubbles; 5.1 Deposit vs. loan bubbles; 5.2 Safe vs. risky bubbles; 6 What have we learned?
Literary Form
non fiction
Description based upon print version of record
Physical Description
1 online resource (52 p.)
Specific Material Designation
Form Of Item

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