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Bank Leverage Regulation and Macroeconomic Dynamics

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Author Info

  • Ian Christensen
  • Césaire Meh
  • Kevin Moran

Abstract

This paper assesses the merits of countercyclical bank balance sheet regulation for the stabilization of financial and economic cycles and examines its interaction with monetary policy. The framework used is a dynamic stochastic general equilibrium model with banks and bank capital, in which bank capital solves an asymmetric information problem between banks and their creditors. In this economy, the lending decisions of individual banks affect the riskiness of the whole banking sector, though banks do not internalize this impact. Regulation, in the form of a constraint on bank leverage, can mitigate the impact of this externality by inducing banks to alter the intensity of their monitoring efforts. We find that countercyclical bank leverage regulation can have desirable stabilization properties, particularly when financial shocks are an important source of economic fluctuations. However, the appropriate contribution of countercyclical capital requirements to stabilization after a technology shock depends on the size of the externality and on the conduct of the monetary authority.

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Bibliographic Info

Paper provided by Bank of Canada in its series Working Papers with number 11-32.

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Length: 43 pages
Date of creation: 2011
Date of revision:
Handle: RePEc:bca:bocawp:11-32

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Keywords: Monetary policy framework; Transmission of monetary policy; Financial institutions; Financial system regulation and policies; Economic models;

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References

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  1. Claudio Borio & Mathias Drehmann, 2009. "Assessing the risk of banking crises - revisited," BIS Quarterly Review, Bank for International Settlements, March.
  2. Claessens, Stijn & Kose, Ayhan & Terrones, Marco E., 2008. "What Happens During Recessions, Crunches and Busts?," CEPR Discussion Papers 7085, C.E.P.R. Discussion Papers.
  3. Francisco Covas & Shigeru Fujita, 2010. "Procyclicality of Capital Requirements in a General Equilibrium Model of Liquidity Dependence," International Journal of Central Banking, International Journal of Central Banking, vol. 6(34), pages 137-173, December.
  4. Christiano, Lawrence & Rostagno, Massimo & Motto, Roberto, 2010. "Financial factors in economic fluctuations," Working Paper Series 1192, European Central Bank.
  5. Clarida, Richard & Galí, Jordi & Gertler, Mark, 1998. "Monetary Policy Rules and Macroeconomic Stability: Evidence and Some Theory," CEPR Discussion Papers 1908, C.E.P.R. Discussion Papers.
  6. Charles T. Carlstrom & Timothy S. Fuerst, 1996. "Agency costs, net worth, and business fluctuations: a computable general equilibrium analysis," Working Paper 9602, Federal Reserve Bank of Cleveland.
  7. Giovanni Dell'Ariccia & Pau Rabanal & Christopher W. Crowe & Deniz Igan, 2011. "Policies for Macrofinancial Stability," IMF Staff Discussion Notes 11/02, International Monetary Fund.
  8. Reinhart, Carmen & Kaminsky, Graciela, 1999. "The twin crises: The causes of banking and balance of payments problems," MPRA Paper 14081, University Library of Munich, Germany.
  9. Christopher J. Erceg & Dale W. Henderson & Andrew T. Levin, 1999. "Optimal monetary policy with staggered wage and price contracts," International Finance Discussion Papers 640, Board of Governors of the Federal Reserve System (U.S.).
  10. Ben Bernanke & Mark Gertler & Simon Gilchrist, 1998. "The Financial Accelerator in a Quantitative Business Cycle Framework," NBER Working Papers 6455, National Bureau of Economic Research, Inc.
  11. Paolo Angelini & Stefano Neri & Fabio Panetta, 2011. "Monetary and macroprudential policies," Temi di discussione (Economic working papers) 801, Bank of Italy, Economic Research and International Relations Area.
  12. Césaire Meh & Kevin Moran, 2008. "The Role of Bank Capital in the Propagation of Shocks," Working Papers 08-36, Bank of Canada.
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