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The effect of macroprudential policy on endogenous credit cycles

Daragh Clancy and Rossana Merola

No 15/RT/14, Research Technical Papers from Central Bank of Ireland

Abstract: The financial sector played a key role in triggering the recent crisis. Negative feedback loops between the financial sector and the real economy have further increased the persistence and amplitude of the downturn. We examine such macrofinancial linkages through the lens of the housing market. We develop a model capable of replicating some key stylised facts from the bursting of the Irish property bubble. We show that expectations of future favourable events may accelerate credit growth and potentially result in a more vulnerable economy susceptible to downward revisions to the original expectations. We find that macro-prudential policy, in particular counter-cyclical capital requirements and larger capital buffers, can play a role in insulating the economy from these risks.

Keywords: DSGE; macro-prudential policy; macro-financial linkages; capital requirements; Ireland. (search for similar items in EconPapers)
JEL-codes: E44 E51 G10 G28 (search for similar items in EconPapers)
Date: 2014-11
New Economics Papers: this item is included in nep-dge, nep-mac, nep-mon and nep-ure
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