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Corrado, Luisa
Schuler, Tobias
Year of Publication: 
Series/Report no.: 
CESifo Working Paper 7422
This paper analyzes the effects of several policy instruments to mitigate financial bubbles generated in the banking sector. We augment a New Keynesian macroeconomic framework by endogenizing boundedly-rational expectations on asset values of loan portfolios and allow for interbank trading. We then show how a financial bubble can develop from a financial innovation. By incorporating a loan management technology and a bank equity channel we can evaluate the efficacy of several policy instruments in counteracting financial bubbles. We find that an endogenous capital requirement reduces the impact of a financial bubble significantly while central bank intervention (“leaning against the wind”) proves to be less effective. A welfare analysis ranks the policy reaction through an endogenous capital requirement as best.
financial bubbles
credit-to-GDP gap
endogenous capital requirement
stabilization policies
Document Type: 
Working Paper

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