The Volatility Costs of Procyclical Lending Standards: An Assessment Using a DSGE Model

Bertrand Gruss and Silvia Sgherri

No ECO2009/07, Economics Working Papers from European University Institute

Abstract: The ongoing financial turmoil has triggered a lively debate on ways of containing systemic risk and lessening the likelihood of future boom-and-bust episodes in credit markets. Particularly, it has been argued that banking regulation might attenuate procyclicality in lending standards by affecting the behavior of banks capital buffers. This paper uses a two-country DSGE model with financial frictions to illustrate how procyclicality in borrowing limits reinforces the ”overreaction” of asset prices to shocks described by Aiyagari and Gertler (1999), and to quantify the stabilization gains from policies aimed at smoothing cyclical swings in credit conditions. Results suggest that, in financially constrained economies, the ensuing volatility reduction in equity prices, investment, and external imbalances would be sizable. In the presence of cross-border spillovers, gains would be even higher.

Keywords: Credit Cycles; Collateral Constraints; DSGE Models (search for similar items in EconPapers)
JEL-codes: E32 F36 F42 (search for similar items in EconPapers)
Date: 2009
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac and nep-reg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (21)

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Working Paper: The Volatility Costs of Procyclical Lending Standards: An Assessment Using a Dsge Model (2009)
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