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

  • Gregory DE WALQUE

    (National Bank of Belgium and University of Namur)

  • Olivier PIERRARD

    (Central Bank of Luxembourg and UNIVERSITE CATHOLIQUE DE LOUVAIN, Institut de Recherches Economiques et Sociales (IRES))

  • Abdelaziz ROUABAH

    (Central Bank of Luxembourg)

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 Based 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 Université catholique de Louvain, Institut de Recherches Economiques et Sociales (IRES) in its series Discussion Papers (IRES - Institut de Recherches Economiques et Sociales) with number 2009006.

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Length: 36
Date of creation: 01 Feb 2009
Date of revision:
Handle: RePEc:ctl:louvir:2009006
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