Viktoriya Hnatkovska

Associate Professor

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Graduate Student Supervision

Doctoral Student Supervision (Jan 2008 - May 2019)
Essays on credit booms and rational bubbles (2017)

Why are credit booms and bubbles harmful to the economy? A dominant view points tothe risk of bust. Traditional theories of bank runs and recent theories of rational bubblesdescribe the costs of jumping to a bad equilibrium when the economy accumulates too muchdebt. In this work, I propose a theory of rational bubbles where the boom, not the ensuingbust, reduces the output by promoting a misallocation of factors.In the model presented in Chapter 2, financial markets are imperfect and the rise of a bubblealleviates credit constraints and boosts capital accumulation. However, capital accumulationoccurs in unproductive sectors and aggregate output is reduced. The result is driven by thefact that heterogeneous borrowers have an advantage with respect to issuing different types ofdebt contracts. In normal times, High-productive borrowers have higher collateral and therebyattract most of the funds. In bubbly times, borrowers can also issue “bubbly debt,” a debtthat is repaid with future debt. The possibility to keep a pyramid scheme and raise bubblydebt depends on the probability of surviving in the market. Therefore, a bubble misallocatesresources towards borrowers with low fundamental risk, even if they invest in projects withlower productivity.In Chapter 3, I propose an augmented version of the model with nominal rigidities. Thegoal is to explain the timing of expansions and recessions during “bubbly episodes.” In thisversion of the model, the initial boom in output is caused by a positive demand effect; thelong run reduction in TFP is driven by a misallocation process. In this chapter, I also analyzethe optimal policy prescriptions. In particular, I stress the importance of the central bankmonopoly on the issuing of bubble-like instruments.Finally, Chapter 4 presents an investigation of American banks’ balance sheets motivatedby the theory of the previous chapters. I test models of credit bubbles versus models of liquiditytransformation. I provide evidence that the recent expansion in liquid debt instruments canbe interpreted by the emergence of a bubble on bank’s liabilities.

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