The IMF Working Papers series is designed to make IMF staff research available to a wide audience. With nearly 300 released each year, working papers cover a wide range of theoretical and analytical topics, including balance of payments, monetary and fiscal issues, global liquidity, and national and international economic developments.
Nina Biljanovska, Lucyna Gornicka, and Alexandros Vardoulakis
INTERNATIONAL MONETARY FUND
An asset bubble relaxes collateral constraints and increases borrowing by credit-constrained
agents. At the same time, as the bubble deflates when constraints start binding, it amplifies
downturns. We show analytically and quantitatively that the macroprudential policy should
optimally respond to building asset price bubbles non-monotonically depending on the underlying
level of indebtedness. If the level of debt is moderate, policy should accommodate the bubble
to reduce the incidence of a binding collateral constraint. If debt is elevated, policy should lean
against the bubble more aggressively to mitigate the pecuniary externalities from a deflating
bubble when constraints bind.