On the Optimality of Bank Capital Requirement Policy in a Macroeconomic Framework

Mario Catalán and Eduardo Ganapolsky

Journal of Applied Economics, 2014, vol. 17, issue 2, 229-255

Abstract: An increasingly widespread “macro-prudential” view holds that bank capital requirements should be loosened during recessions and tightened during expansions to avoid excessive credit and output swings. We present a dynamic general equilibrium framework that accounts for the effects of capital requirement policies on the saving decisions of households, and, through this channel, on bank loans and output. We evaluate optimal capital requirement policy in the presence of loan write-offs (loan supply) and productivity (loan demand) shocks. We show that capital requirements should be reduced in response to unanticipated loan write-offs. We also show that capital requirements should be tightened in anticipation of future declines in productivity, and loosened at the onset of recessions. We conclude that macro-prudential capital requirement policies can be optimal from a welfare standpoint, but they can also generate output and credit booms through general equilibrium effects.

Date: 2014
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DOI: 10.1016/S1514-0326(14)60011-8

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