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Discussion Paper Details

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Title: The International Transmission of Credit Bubbles: Theory and Policy

Author(s): Alberto Mart�n and Jaume Ventura

Publication Date: February 2015

Keyword(s): asset bubbles, capital controls, exchange rates, financial globalization, interest rates and international capital controls

Programme Area(s): Financial Economics and International Macroeconomics

Abstract: We live in a new world economy characterized by financial globalization and historically low interest rates. This environment is conducive to countries experiencing credit bubbles that have large macroeconomic effects at home and are quickly propagated abroad. In previous work, we built on the theory of rational bubbles to develop a framework to think about the origins and domestic effects of these credit bubbles. This paper extends that framework to two-country setting and studies the channels through which credit bubbles are transmitted across countries. We find that there are two main channels that work through the interest rate and the terms of trade. The former constitutes a negative spillover, while the latter constitutes a negative spillover in the short run but a positive one in the long run. We study both cooperative and noncooperative policies in this world. The interest-rate and terms-of-trade spillovers produce policy externalities that make the noncooperative outcome suboptimal.

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Bibliographic Reference

Mart�n, A and Ventura, J. 2015. 'The International Transmission of Credit Bubbles: Theory and Policy'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=10396