Macro-prudential Policy in a Fisherian Model of Financial Innovation
IMF Working Papers, July 1, 2012
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- Macro-prudential Policy in a Fisherian Model of Financial Innovation
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Bibliographic details
- Authors: Javier Bianchi, Emine Boz, Enrique G. Mendoza
- Published: July 1, 2012
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781475505290.001
Summary
- Authors: Javier Bianchi, Emine Boz, Enrique G. Mendoza
- Date: July 1, 2012
- Core focus: Interaction between credit frictions, financial innovation, and a switch from optimistic to pessimistic beliefs as drivers of financial amplification; study of macro-prudential policy effects within that framework.
- Key mechanism: Financial innovation increases agents' ability to collateralize assets into debt, while the riskiness of the new regime is learned over time through observed realizations of financial conditions.
- Learning and beliefs: Beliefs about transition probabilities across states with high and low ability to borrow change as agents learn.
- Externality: The collateral constraint introduces a pecuniary externality because agents fail to internalize the effect of their borrowing decisions on asset prices.
Model features and assumptions
- Quantitative general equilibrium framework capturing:
- Credit frictions
- Financial innovation that expands collateralization into debt
- Bayesian-style updating of beliefs about transition probabilities across borrowing-ability states (high and low)
- A collateral constraint that generates a pecuniary externality through asset price effects
- Dynamics: The riskiness of the financial innovation regime is not immediately known and must be inferred over time from realized financial conditions.
Quantitative findings
- Effectiveness of macro-prudential policy depends on:
- The government's information set (how informed the government is relative to private agents)
- The tightness of credit constraints
- 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
- Optimism builds quickly
Policy implications and recommendations
- Macro-prudential policy design should account for:
- Information asymmetries between government and private agents
- Endogenous belief dynamics driven by learning about transition probabilities
- The degree of tightness in credit constraints and the speed of optimism growth during financial innovation
- Targeting and timing of macro-prudential interventions should consider the limited effectiveness when the government lacks superior information, when credit constraints are tight, and when optimism escalates rapidly.
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