Optimal macroprudential regulation in a Fisherian model of financial crises

Financial crises of the magnitude that caused the ongoing Great Recession are relatively rare but dramatic and socially costly events. As was the case with the 1990s emerging markets crises or the Great Depression of the 1930s, the Great Recession was preceded by prolonged booms in credit, economic activity and asset prices, followed by a sharp, sudden crash. This observation has made policymakers wary of periods of rapid credit expansion and surging asset prices, and has led to the view that financial regulation is in urgent need of revamping to incorporate a macroprudential focus to contain systemic excessive borrowing in the expansionary phase of the credit cycle. Research on the development of the macrofinancial framework that is required to construct quantitative models to inform the design of this new regulation is at an early stage. We report in this paper on some of the key lessons that follow from the research we are conducting to contribute to fill this gap (see Bianchi and Mendoza (2011) for further details).