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Financial Regulation in General Equilibrium

  • Charles A.E. Goodhart
  • Anil K Kashyap
  • Dimitrios P. Tsomocos
  • Alexandros P. Vardoulakis

This paper explores how different types of financial regulation could combat many of the phenomena that were observed in the financial crisis of 2007 to 2009. The primary contribution is the introduction of a model that includes both a banking system and a "shadow banking system" that each help households finance their expenditures. Households sometimes choose to default on their loans, and when they do this triggers forced selling by the shadow banks. Because the forced selling comes when net worth of potential buyers is low, the ensuing price dynamics can be described as a fire sale. The proposed framework can assess five different policy options that officials have advocated for combating defaults, credit crunches and fire sales, namely: limits on loan to value ratios, capital requirements for banks, liquidity coverage ratios for banks, dynamic loan loss provisioning for banks, and margin requirements on repurchase agreements used by shadow banks. The paper aims to develop some general intuition about the interactions between the tools and to determine whether they act as complements and substitutes.

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File URL: http://www.nber.org/papers/w17909.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 17909.

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Date of creation: Mar 2012
Date of revision:
Handle: RePEc:nbr:nberwo:17909
Note: ME CF EFG
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  1. Dimitrios P Tsomocos & Charles A.E. Goodhart, 2003. "A Model to Analyse Financial Fragility," Economics Series Working Papers 2003-FE-13, University of Oxford, Department of Economics.
  2. Dimitrios P Tsomocos, 2000. "Equilibrium Analysis, Banking and Financial Instability," Economics Series Working Papers 2003-FE-08, University of Oxford, Department of Economics.
  3. Diamond, Douglas W, 1984. "Financial Intermediation and Delegated Monitoring," Review of Economic Studies, Wiley Blackwell, vol. 51(3), pages 393-414, July.
  4. Lasse Heje Pederson & Markus K Brunnermeier, 2007. "Market Liquidity and Funding Liquidity," FMG Discussion Papers dp580, Financial Markets Group.
  5. Douglas W. Diamond & Raghuram G. Rajan, 1999. "A Theory of Bank Capital," NBER Working Papers 7431, National Bureau of Economic Research, Inc.
  6. Tobias Adrian & Hyun Song Shin, 2009. "Money, liquidity, and monetary policy," Staff Reports 360, Federal Reserve Bank of New York.
  7. Pradeep Dubey & John Geanakoplos, 2006. "Determinacy with nominal assets and outside money," Economic Theory, Springer, vol. 27(1), pages 79-106, 01.
  8. Franklin Allen & Douglas Gale, 2005. "From Cash-in-the-Market Pricing to Financial Fragility," Journal of the European Economic Association, MIT Press, vol. 3(2-3), pages 535-546, 04/05.
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