Asset bubbles play role in macro-prudential policy – IMF research

The size of asset bubbles may determine the level of taxation authorities should implement to address credit imbalances, says research published by the International Monetary Fund.

In Optimal Macroprudential Policy and Asset Price Bubbles, Nina Bijanovska, Lucyba Gornicka and Alexandros Vardoulakis study macro-prudential policies when credit imbalances are accompanied by an asset price bubble.

In bad times, “the presence of a bubble generates an additional pecuniary externality, which requires further macro-prudential intervention in order to avoid a bubble deflation”, say the authors.

However, the presence of asset bubbles alters equilibrium allocations and, by helping “to keep collateral constraints slack” for some types of shock, this may result “in a macro-prudential tax on borrowing that is lower relative to the bubbleless case”, they add.

In fact, in cases when credit imbalances are moderate, the optimal tax level is thought to be lower in the presence of the bubble, say Bijanovska, Gornicka and Vardoulakis. “However, when the credit imbalances are high, the optimal tax level is much higher than in the absence of the bubble, suggesting the presence of an amplifying effect from elevated credit imbalances and asset overvaluations.”