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Financial (In)stability, Supervision and Liquidity Injections: A Dynamic General Equilibrium Approach

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Author Info
de Walque, Gregory
Pierrard, Olivier
Rouabah, Abdelaziz

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Abstract

We develop a dynamic stochastic general equilibrium model with an heterogeneous banking sector. 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 interactions between the banking sector and the rest of the economy, as well as the importance of supervisory and monetary authorities to restore financial stability. The model is calibrated against real US data and used for simulations. We show that Basel regulation reduces the steady state but improves the resilience of the economy to shocks, and that moving from Basel I to Basel II is procyclical. We also show that liquidity injections relieve financial instability but have ambiguous effects on output fluctuations.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 7202.

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Date of creation: Mar 2009
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Handle: RePEc:cpr:ceprdp:7202

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Related research
Keywords: banking sector; central bank; default risk; DSGE; supervision;

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Find related papers by JEL classification:
E13 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Neoclassical
E20 - Macroeconomics and Monetary Economics - - Macroeconomics: Consumption, Saving, Production, Employment, and Investment - - - General (includes Measurement and Data)
G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Mortgages
G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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  2. Stock, James H. & Watson, Mark W., 1999. "Business cycle fluctuations in us macroeconomic time series," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 1, pages 3-64 Elsevier. [Downloadable!] (restricted)
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  14. David VanHoose, 2008. "Bank Capital Regulation, Economic Stability, and Monetary Policy: What Does the Academic Literature Tell Us?," Atlantic Economic Journal, International Atlantic Economic Society, vol. 36(1), pages 1-14, March. [Downloadable!] (restricted)
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  19. King, Robert G. & Rebelo, Sergio T., 1999. "Resuscitating real business cycles," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 14, pages 927-1007 Elsevier. [Downloadable!] (restricted)
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