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Financial (in)stability, supervision and liquidity injections: a dynamic general equilibrium approach

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  • Gregory de Walque

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  • Olivier Pierrard

    ()

  • Abdelaziz Rouabah

    ()

Abstract

This paper develops a dynamic stochastic general equilibrium model with interactions between a heterogeneous banking sector and other private agents. We introduce endogenous default probabilities for both firms and banks, and allow for bank regulation and liquidity injection into the interbank market. Our aim is to understand the importance of supervisory and monetary authorities to restore financial stability. The model is calibrated against real data and used for simulations. We show that liquidity injections reduce financial instability but have ambiguous effects on output fluctuations. The model also confirms the partial equilibrium literature results on the procyclicality of Basel II.

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File URL: http://www.bcl.lu/fr/publications/cahiers_etudes/35/BCLWP035.pdf
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Bibliographic Info

Paper provided by Central Bank of Luxembourg in its series BCL working papers with number 35.

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Length: 38 pages
Date of creation: Oct 2008
Date of revision:
Publication status: published in The Economic Journal, 2010, 120: 1234-1261
Handle: RePEc:bcl:bclwop:bclwp035

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Web page: http://www.bcl.lu/

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Keywords: DSGE; Banking sector; Default risk; Supervision; Money;

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