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Policy talks about bubbles and regulation have reemerged. Check out my paper w/
@NinaBiljanovska
& @LGornicka on the optimal macroprudential regulation to tackle asset price bubble https://drive.google.com/file/d/16s1wEeetuzHzNqrQx_AA0eqnf7LaqqNJ/view. Should we get tougher? Answer is: It depends.. https://twitter.com/Reuters/status/1317558527335059456
@NinaBiljanovska
& @LGornicka on the optimal macroprudential regulation to tackle asset price bubble https://drive.google.com/file/d/16s1wEeetuzHzNqrQx_AA0eqnf7LaqqNJ/view. Should we get tougher? Answer is: It depends.. https://twitter.com/Reuters/status/1317558527335059456
Picture below summarizes the main point. If firms are not very indebted, relaxing regulation to help the bubble grow is good: Bubbles relax financial constraints. But if indebteness is high, much stricter regulation is needed to avoid a costly bubble deflation in the future
Creditors often ask “what is the value of a restructured firm including all its intangibles” rather than “what is the value if the firm is broken to pieces and its assets sold independently”. Bubble increases the value of the firm and helps it borrow more easily
While firms have moderate debt, feeding the bubble is good because it help them borrow and produce more. But the bubble can deflate fast when over-indebted firms find themselves in trouble rolling over their debt in the future
This is bad because it induces a spiral of fire-sales adversely affecting production. Preemptively is a good idea to lean against overborrowing ESPECIALLY WHEN asset bubbles have grown rather than when there are no bubbles
