The Myth of Financial Innovation and the Great Moderation

88 Pages Posted: 17 Nov 2009

See all articles by Wouter J. den Haan

Wouter J. den Haan

University of Amsterdam; Centre for Economic Policy Research (CEPR); Tinbergen Institute

Vincent Sterk

University College London

Date Written: October 2009

Abstract

Financial innovation is widely believed to be at least partly responsible for the recent financial crisis. At the same time, there are empirical and theoretical arguments that support the view that changes in financial markets played a role in the "great moderation". If both are true, then the price of reducing the likelihood of another crisis, e.g., through new regulation, could be giving up another episode of sustained growth and low volatility. However, this paper questions empirical evidence supporting the view that innovation in consumer credit and home mortgages reduced cyclical variations of key economic variables. We find that especially the behaviour of aggregate home mortgages changed less during the great moderation than is typically believed. For example, aggregate home mortgages declined during monetary tightenings, both before and during the great moderation. A remarkable change we do find is that monetary tightenings became episodes during which financial institutions other than banks increased their holdings in mortgages. Once can question the desirability of such strong substitutions of ownership during economic downturns.

Keywords: consumer credit, impulse response functions, mortgages

JEL Classification: E32, E44, G21

Suggested Citation

Den Haan, Wouter J. and Sterk, Vincent, The Myth of Financial Innovation and the Great Moderation (October 2009). CEPR Discussion Paper No. DP7507, Available at SSRN: https://ssrn.com/abstract=1507504

Wouter J. Den Haan (Contact Author)

University of Amsterdam ( email )

Spui 21
Amsterdam, 1018 WB
Netherlands

HOME PAGE: http://www1.feb.uva.nl/toe/content/people/content/denhaan/pers.htm

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Tinbergen Institute ( email )

Burg. Oudlaan 50
Rotterdam, 3062 PA
Netherlands

Vincent Sterk

University College London ( email )

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