Do Capital Adequacy Requirements Matter for Monetary Policy?

Stephen Cecchetti and Lianfi Li

No 11830, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: Central bankers and financial supervisors often have different goals. While monetary policymakers want to ensure that there are always sufficient lending activities to maintain high and stable economic growth, supervisors work to limit banks. lending capacities in order to prevent excessive risk-taking. To avoid working at cross-purposes, central bankers need to adopt a policy strategy that accounts for the impact of capital adequacy requirements. In this paper we derive an optimal monetary policy that reinforces prudential capital requirements at the same time that it stabilizes aggregate economic activity. We go on to show that policymakers at the Federal Reserve adjust interest rate policy in a way that would neutralize the procyclical impact of bank capital requirements. By contrast, central bankers in Germany and Japan clearly do not act as the theory suggests they should.

JEL-codes: E52 E58 G21 (search for similar items in EconPapers)
Date: 2005-12
New Economics Papers: this item is included in nep-cba, nep-fin, nep-fmk, nep-mac and nep-mon
Note: ME
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Citations: View citations in EconPapers (23)

Published as Stephen G. Cecchetti & Lianfa Li, 2008. "Do Capital Adequacy Requirements Matter For Monetary Policy?," Economic Inquiry, Western Economic Association International, vol. 46(4), pages 643-659, October.

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Journal Article: DO CAPITAL ADEQUACY REQUIREMENTS MATTER FOR MONETARY POLICY? (2008)
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