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

Jagjit Chadha and Luisa Corrado

No 193, CEIS Research Paper from Tor Vergata University, CEIS

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.

Keywords: Liquidity; interest on reserves; policy instruments; Basel. (search for similar items in EconPapers)
JEL-codes: E31 E40 E51 (search for similar items in EconPapers)
Pages: 41 pages
Date: 2011-05-02, Revised 2011-05-02
New Economics Papers: this item is included in nep-ban, nep-cba, nep-dge, nep-mac and nep-mon
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Citations: View citations in EconPapers (3)

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Related works:
Journal Article: Macro-prudential policy on liquidity: What does a DSGE model tell us? (2012)
Working Paper: Macro-prudential Policy on Liquidity: What does a DSGE Model tell us? (2011)
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