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Time-varying capital requirements in a general equilibrium model of liquidity dependence

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Author Info

  • Francisco Covas
  • Shigeru Fujita

Abstract

This paper attempts to quantify business cycle effects of bank capital requirements. The authors use a general equilibrium model in which financing of capital goods production is subject to an agency problem. At the center of this problem is the interaction between entrepreneurs' moral hazard and liquidity provision by banks as analyzed by Holmstrom and Tirole (1998). They impose capital requirements on banks and calibrate the regulation using the Basel II risk-weight formula. Comparing business cycle properties of the model under this procyclical regulation with those under hypothetical countercyclical regulation, the authors find that output volatility is about 25 percent larger under procyclical regulation and that this volatility difference implies a 1.7 percent reduction of the household's welfare. Even with more conservative parameter choices, the volatility and welfare differences under the two regimes remain nonnegligible.

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Bibliographic Info

Paper provided by Federal Reserve Bank of Philadelphia in its series Working Papers with number 09-23.

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Date of creation: 2009
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Handle: RePEc:fip:fedpwp:09-23

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Related research

Keywords: Bank capital ; Business cycles ; Bank reserves;

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Cited by:
  1. Agénor, P.-R. & Alper, K. & Pereira da Silva, L., 2012. "Capital requirements and business cycles with credit market imperfections," Journal of Macroeconomics, Elsevier, vol. 34(3), pages 687-705.
  2. R. P. Agenor & K. Alper & L. Pereira da Silva, 2013. "Capital Regulation, Monetary Policy, and Financial Stability," International Journal of Central Banking, International Journal of Central Banking, vol. 9(3), pages 198-243, September.
  3. Roland Winkler & Ignazio Angeloni, 2011. "Exit Strategies," 2011 Meeting Papers 241, Society for Economic Dynamics.
  4. Daniel Sámano, 2011. "In the Quest of Macroprudential Policy Tools," Working Papers 2011-17, Banco de México.
  5. Maria Th. Kasselaki & Athanasios O. Tagkalakis, 2013. "Financial soundness indicators and financial crisis episodes," Working Papers 158, Bank of Greece.
  6. Paolo Angelini & Sergio Nicoletti-Altimari & Ignazio Visco, 2012. "Macroprudential, microprudential and monetary policies: conflicts, complementarities and trade-offs," Questioni di Economia e Finanza (Occasional Papers) 140, Bank of Italy, Economic Research and International Relations Area.
  7. 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.

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