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Macro-prudential Policy on Liquidity: What Does a DSGE Model Tell Us?

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Abstract

The financial crisis has led to the development of an active debate on the use of macro-prudential instruments for regulating the banking system, in particular for liquidity and capital holdings. Within the context of a micro-founded macroeconomic model, we allow commercial banks to choose their optimal mix of asset creation, apportioning this to either reserves or private sector loans. We examine the implications for quantities, relative non-financial and financial prices from standard macroeconomic shocks alongside shocks to the expected liquidity of banks and to the efficiency of the banking sector. We focus on the response by the monetary sector, in particular the optimal reserve-deposit ratio adopted by commercial banks. Overall we find some rationale for Basel III in providing commercial banks with an incentive to hold liquid assets, such as reserves, as this acts to limit the procyclicality of lending to the private sector.

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Bibliographic Info

Paper provided by Tor Vergata University, CEIS in its series CEIS Research Paper with number 193.

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Length: 41 pages
Date of creation: 02 May 2011
Date of revision: 02 May 2011
Handle: RePEc:rtv:ceisrp:193

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Postal: CEIS - Centre for Economic and International Studies - Faculty of Economics - University of Rome "Tor Vergata" - Via Columbia, 2 00133 Roma
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Postal: CEIS - Centre for Economic and International Studies - Faculty of Economics - University of Rome "Tor Vergata" - Via Columbia, 2 00133 Roma
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Web: http://www.ceistorvergata.it

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Keywords: Liquidity; interest on reserves; policy instruments; Basel.;

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References

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  1. King, Robert G & Watson, Mark W, 1998. "The Solution of Singular Linear Difference Systems under Rational Expectations," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 39(4), pages 1015-26, November.
  2. Scott Freeman & Joseph H. Haslag, 1993. "On the optimality of interest-bearing reserves in economies of overlapping generations," Research Paper 9328, Federal Reserve Bank of Dallas.
  3. 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.
  4. Marvin Goodfriend & Bennett T. McCallum, 2007. "Banking and interest rates in monetary policy analysis: a quantitative exploration," Proceedings, Federal Reserve Bank of San Francisco.
  5. Baltensperger, Ernst, 1980. "Alternative approaches to the theory of the banking firm," Journal of Monetary Economics, Elsevier, vol. 6(1), pages 1-37, January.
  6. Smith, B.D., 1988. "Interest On Reserves And Sunspot Equilibria: Friedman'S Proposal Reconsidered," RCER Working Papers 119, University of Rochester - Center for Economic Research (RCER).
  7. Marvin Goodfriend, 2002. "Interest on reserves and monetary policy," Economic Policy Review, Federal Reserve Bank of New York, issue May, pages 77-84.
  8. Hall Robert, 2002. "Controlling the Price Level," The B.E. Journal of Macroeconomics, De Gruyter, vol. 2(1), pages 1-21, July.
  9. Tobias Adrian & Hyun Song Shin, 2008. "Liquidity, monetary policy, and financial cycles," Current Issues in Economics and Finance, Federal Reserve Bank of New York, vol. 14(Jan).
  10. Sargent, Thomas & Wallace, Neil, 1985. "Interest on reserves," Journal of Monetary Economics, Elsevier, vol. 15(3), pages 279-290, May.
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Cited by:
  1. Jagjit S. Chadha & Luisa Corrado & Jack Meaning, 2012. "Reserves, Liquidity and Money: An Assessment of Balance sheet Policies," Studies in Economics 1208, Department of Economics, University of Kent.
  2. Jagjit S. Chadha & Elisa Newby, 2013. "’Midas, transmuting all, into paper’: the Bank of England and the Banque de France during the Napoleonic Wars," Cambridge Working Papers in Economics 1330, Faculty of Economics, University of Cambridge.
  3. Leo de Haan & Jan Willem van den End, 2012. "Bank liquidity, the maturity ladder, and regulation," DNB Working Papers 346, Netherlands Central Bank, Research Department.
  4. Chadha , Jagjit S. & Newby, Elisa, 2013. "Midas, transmuting all, into paper: The Bank of England and the Banque de France during the Revolutionary and Napoleonic Wars," Research Discussion Papers 20/2013, Bank of Finland.
  5. Jan Willem van den End, 2013. "A macroprudential approach to address liquidity risk with the Loan-to-Deposit ratio," DNB Working Papers 372, Netherlands Central Bank, Research Department.
  6. Falagiarda, Matteo, 2013. "Evaluating Quantitative Easing: A DSGE Approach," MPRA Paper 49457, University Library of Munich, Germany.

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