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A dilemma between liquidity regulation and monetary policy: some history and theory

Eric Monnet () and Miklos Vari ()

No 15001, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: History suggests a conflict between current Basel III liquidity ratios and monetary policy, which we call the liquidity regulation dilemma. Although forgotten, liquidity ratios, named "securities-reserve requirements", were widely used historically, but for monetary policy (not regulatory) reasons, as central bankers recognized the contractionary effects of these ratios. We build a model rationalizing historical policies: a tighter ratio reduces the quantity of assets that banks can pledge as collateral, thus increasing interest rates. Tighter liquidity regulation paradoxically increases the need for central bank's interventions. Liquidity ratios were also used to keep yields on government bonds low when monetary policy tightened

Keywords: Basel III; central bank history; Liquidity coverage ratio (LCR); liquidity ratios; Monetary policy implementation; reserve requirements (search for similar items in EconPapers)
JEL-codes: E43 E52 E58 G28 N10 N20 (search for similar items in EconPapers)
Date: 2020-07
New Economics Papers: this item is included in nep-ban, nep-cba, nep-his, nep-mac and nep-mon
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