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Business Cycle and Bank Capital: Monetary Policy Transmission under the Basel Accords

Alvaro Aguiar () and Ines Drumond ()
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Alvaro Aguiar: CEMPRE, Faculdade de Economia, Universidade do Porto, Portugal

FEP Working Papers from Universidade do Porto, Faculdade de Economia do Porto

Abstract: This paper improves the analysis of the role of financial frictions in the transmission of monetary policy and in business cycle fluctuations, by focusing on an additional channel working through bank capital. Detailing a dynamic general equilibrium model, in which households require a (countercyclical) liquidity premium to hold bank capital, we find that, together with the financial accelerator, the introduction of regulatory bank capital significantly amplifies monetary shocks through a liquidity premium effect on the external finance premium faced by firms. This amplification effect is larger under Basel II than under Basel I regulatory rules. Indeed, introducing bank capital enhances the role of financial frictions in the propagation of shocks, in line with arguments in related literature.

Keywords: Bank capital channel; Bank capital requirements; Financial accelerator; Liquidity premium; Monetary transmission mechanism; Basel Accords (search for similar items in EconPapers)
JEL-codes: E44 E32 E52 G28 (search for similar items in EconPapers)
Pages: 55 pages
Date: 2007-06
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac, nep-mon and nep-reg
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