Ballooning finance

Bruno Biais, Jean-Charles Rochet, Paul Woolley 21 August 2014

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One of the curiosities of the modern economy is why the finance sector is so large. Economists have only recently sought to document and ponder this phenomenon. Empirically, Greenwood and Scharfstein (2013) find that, in the US, financial services, which accounted for 2.8% of GDP in 1950, made up 8.3% of GDP in 2006.

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Topics:  Financial markets

Tags:  securitisation, financial crises, moral hazard, asymmetric information, financial innovation, global crisis, bubbles, monitoring, shirking, junk bonds, CDOs, CDSs, ETFs

Managing credit bubbles

Alberto Martin, Jaume Ventura 05 July 2014

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Credit markets play an increasingly central role in modern economies. Within the OECD, for instance, domestic credit has risen from 100% of GDP in 1970 to approximately 160% of GDP in 2012 (as measured by the Bank for International Settlements). To be sure, this growth masks large variations across countries and over time, but there is a common feature to all these different country experiences that stands out. Credit has often alternated between ‘booms’ – periods of rapid growth – and ‘busts’ – periods of stagnation or significant decline.

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Topics:  Financial markets Macroeconomic policy

Tags:  credit booms, lender of last resort, bubbles, credit, Leaning against the wind, collateral, financial accelerator

Capital inflows and booms in asset prices: Going beyond the current account

Eduardo Olaberría 07 December 2013

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For decades, policymakers’ perception has been that large capital inflows can fuel booms in asset prices. If this were true, bonanzas in capital inflows would imply an important risk to financial stability, since booms in asset prices are leading indicators of financial crises. However, as noted by Reinhart and Reinhart (2008: 50), despite being widespread among policymakers, until recently this perception was based mainly on anecdotal evidence.

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Topics:  Financial markets International finance

Tags:  capital flows, asset prices, current account, bubbles, Capital inflows, booms

Political Credit Cycles: The Case of the Euro Zone

Jesús Fernández-Villaverde, Luis Garicano, Tano Santos,

Date Published

Sun, 03/24/2013

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Understanding bubbly episodes

Jaume Ventura, Vasco M. Carvalho, Alberto Martin 09 September 2012

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Wealth has fluctuated substantially in recent US macroeconomic history. Figure 1 below documents this by plotting the evolution of real net worth of US households and non-profit organisations between 1950 and 2010. Up until the early 1990s the evolution of wealth seems relatively stable, displaying only mild and short-lived fluctuations around its trend. Since then, however, this behaviour has changed dramatically. From 1995 to 1999, and again from 2002 to 2006, wealth grew at a staggering 9% per year only to contract violently in subsequent years.

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Topics:  Global economy International finance

Tags:  US, asset bubbles, bubbles

Market psychology, high unemployment and rational bubbles

Roger E. A. Farmer 18 August 2011

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According to a popular narrative (e.g. Shiller 2008), the Great Recession was caused by a bubble in the housing market. When the bubble burst, households were left with mortgages that exceeded the values of their houses. When they stopped spending, the resulting fall in consumer demand triggered an increase in unemployment. The drop in housing wealth was accompanied by a stock market crash, precipitated by the failure of Lehman Brothers in the fall of 2007.

Although this narrative fits the facts, it poses two major difficulties for conventional microeconomic theory.

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Topics:  Frontiers of economic research

Tags:  unemployment, psychology, bubbles, rational expectations

Simple explanations for global financial instability and the cure: Keep it simple

Daniel Gros, Stefano Micossi, Jacopo Carmassi 13 August 2009

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A remarkable feature of the burgeoning literature on the global financial crisis is vast disagreement about its main causes. Symptoms are often treated as autonomous developments requiring separate correction. There is thus a high risk that the legitimate pursuit of a more stable financial system will lead to a potpourri of excessive and damaging regulatory restrictions. In hope of reducing that risk, we offer a simplified reading of the factors leading to the financial crisis and accordingly simple policy recommendations (Carmassi, Gros, and Micossi 2010).

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Topics:  International finance

Tags:  financial crisis, leverage, bubbles