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Macroprudential Policy with Liquidity Panics

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  • Daniel Garcia-Macia
  • Alonso Villacorta

Abstract

We study the optimality of macroprudential policies in an environment where banks provide liquidity to firms. Informational frictions between banks can cause interbank market freezes, prompting firms to accumulate their own liquid assets. Liquidity hoarding by firms in turn reduces the demand for bank loans and bank profitability, makes interbank market freezes even more likely, and may ultimately trigger a self-fulfilling bad equilibrium. Such “liquidity panics” provide an additional rationale for liquidity requirements on banks, which alleviate frictions in the banking sector and, paradoxically, can increase aggregate investment. Instead, policies encouraging bank lending can have the opposite effect.

Suggested Citation

  • Daniel Garcia-Macia & Alonso Villacorta, 2023. "Macroprudential Policy with Liquidity Panics," The Review of Financial Studies, Society for Financial Studies, vol. 36(5), pages 2046-2090.
    • Handle: RePEc:oup:rfinst:v:36:y:2023:i:5:p:2046-2090.
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    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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