Macroprudential Policy in a Bubble-Creation Economy

Pongsak Luangaram and Athakrit Thepmongkol

No 22, PIER Discussion Papers from Puey Ungphakorn Institute for Economic Research

Abstract: This paper analyzes macroprudential policy in the form of loan-to-value (LTV) restriction in a bubble-creation economy of Martin and Ventura (forth- coming). We find that implementation of LTV policy may generate multiple equilibria. Moreover, its effectiveness in terms of investment and size of bubbles depends on the degree of financial friction. In high-capital steady state, low (high) financial friction implies that bubbles originally crowd out (in) investment, so that implementation of LTV policy causes bubbles to decrease (remain unchanged) and enhances (reduces) investment. However, in low-capital equilibrium, the policy has ambiguous effects. LTV policy may help to lower the possibility of sunspot equilibria in two aspects: (1) by destabilizing the low-capital steady state and (2) by confining the set of consistent market sentiments in the presence of high financial friction.

Keywords: Rational bubbles; Bubble creation; Macroprudential policy; Loan-to-value ratio; Overlapping generations model; Financial friction (search for similar items in EconPapers)
JEL-codes: E44 F41 G12 (search for similar items in EconPapers)
Pages: 24 pages
Date: 2016-03
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