When government expenditure meets bank regulation: The impact of government expenditure on credit supply

I develop a banking model to examine the effects of government expenditures on the credit and money supply under Basel III regulations. Purchases of goods and services from real firms or transfer payments to households as conventional government expenditures (CGEs) inject reserves into banks. Purchases of equity from banks as unconventional government expenditures (UGEs) inject equity into banks. Three Basel III regulations are examined: the capital adequacy ratio, liquidity coverage ratio, and net stable funding ratio. My results demonstrate that the CGE or UGE causes multiplier effects on the credit supply. The multiplier greater (less) than one means that banks amplify (contract) the government expenditure. Multiplier effects on the money supply in response to the CGE or UGE are also presented. My paper sheds considerable light on how government expenditure and bank regulation simultaneously affect the credit and money supply.