The Limits to Credit Growth: Mitigation Policies and Macroprudential Regulations to Foster Macrofinancial Stability and Sustainable Debt

Abstract

We study an economy with a high degree of financialization in which (non-financial) firms need loans from commercial banks to finance production, service debt, and make long-term investments. Along the business cycle, the economy follows Minskyan dynamics with firms traversing various stages of financial fragility, i.e. hedge, speculative and Ponzi finance (cf., Minsky, 1978Minsky, , 1986. In the speculative finance stage, cash flows are insufficient to finance debt repayments, and banks are willing to provide roll-over credits in order to prevent a default on the debt. In the Ponzi finance stage, banks are still willing to keep firms alive through "extend and pretend" loans, also known as zombie-lending (Caballero et al., 2008). This lending behavior may cause credit bubbles with increasing leverage ratios. Empirical evidence suggests that recessions following such leveraging booms are more severe and can be associated to higher economic costs (Jordà et al., 2011;Schularick and Taylor, 2012).We therefore study policy measures that might mitigate the severity and intensity of the economic losses ensuing from such severe downturns. We investigate micro-and macroprudential regulations aimed at: (i) the prevention and mitigation of credit bubbles, (ii) ensuring macro-financial stability, and (iii) limiting the ability of banks to create unsustainable debt. Our results show that the use of non-risk-weighted capital ratios have slightly positive effects, while cutting-off funding to all financially unsound firms (speculative and Ponzi) has very strong positive effects. However, merely cutting-off funds to Ponzi financed firms has hardly any effect at all.

Agent-Based Macroeconomics

“…These claims are verified across different Taylor rules that are inserted into the model. Comparing these findings with those of van der Hoog and Dawid (2017) and van der Hoog (2018), discussed above, one has to acknowledge that, whereas the importance of the countercyclical buffer seems consistent with the intuition of the importance of bubble prevention in these papers, the negative role of the liquidity constraint is at odds with the main findings in van der Hoog and Dawid (2017) and van der Hoog (2018). This observation highlights the importance of taking into account the details of the underlying macroeconomic setup when interpreting the qualitative insights from policy analyses.…”

“…Fiscal policies are analysed in Harting (2015) and Dawid et al (2018b). Two papers on financial and macro-prudential issues: van der Hoog and Dawid (2017), van der Hoog (2018). The nexus of skill dynamics, innovation and growth in multi-regional settings is explored in Dawid et al (2008Dawid et al ( , 2013.…”

A basic macroeconomic agent-based model for analyzing monetary regime shifts

“…Furthermore, the distinction between productive and unproductive credits is expedient to identify macro-financial stability effects of different monetary regimes. Unproductive credits might be induced by rolling over of existing debt, leading to unnecessary prolongation of firm existence with high default risk [23,36].…”

“…The offered interest rate is composed of the key rate (Section 3.6.2) + the fixed standing facility spread of 1% (Section 3.6.1) + margin/mark-up 11. In line with van der Hoog [23], the loan duration is assumed to be 18 periods. The expected profit is the linear extrapolation of firm turnover over the last three periods plus nominal variation of inventories, deposit interest earnings minus wages, and interest costs [42].…”

“…Consequently, we find a few agent-based models that analyze, if not regime shifts, but the impact of policy variations, which partially incorporate specifications of the current monetary system [22][23][24][25]. Here, we contribute with a basic model that captures the main systemic risk features of the current monetary system.…”