Unconventional Monetary Policy and the Safety of the Banking System

Martine Quinzii

No 1511, 2016 Meeting Papers from Society for Economic Dynamics

Abstract: This paper presents a simple model of banking equilibrium in which unconventional monetary policy serves as a tool to enhance the safety of the banking system. Every economy has two intrinsic characteristics: a ``natural'' debt-equity ratio which depends on the endowments of the infinitely risk averse safe-debt providers and the risk neutral equity providers, and a ``critical'' debt-equity ratio which depends only on the risks inherent in the banks' productive loans. When the natural debt-equity ratio exceeds the critical ratio, there is a positive probability of bankruptcy in equilibrium. In such ``high debt'' economies, standard banking equilibria are inefficient regardless of the capital requirement imposed by regulators. However unconventional monetary policy using the balance sheet of the Central Bank in conjunction with a standard equity requirement can restore the Pareto optimality of the banking equilibrium.

Date: 2016
New Economics Papers: this item is included in nep-cba and nep-mon
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed016:1511

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