Financial Regulation in General Equilibrium
London School of Economics & Political Science (LSE) - Financial Markets Group
Anil K. Kashyap
University of Chicago - Booth School of Business; National Bureau of Economic Research (NBER)
Dimitrios P. Tsomocos
University of Oxford - Said Business School and St. Edmund Hall
Federal Reserve Board; European Central Bank (ECB) - Directorate General Research; Banque de France
March 1, 2012
Banque de France Working Paper No. 372
This paper explores how different types of financial regulation could combat many of the phenomena that were observed in the financial crisis of 2007 to 2009. The primary contribution is the introduction of a model that includes both a banking system and a “shadow banking system” that each help households finance their expenditures. Households sometimes choose to default on their loans, and when they do this triggers forced selling by the shadow banks. Because the forced selling comes when net worth of potential buyers is low, the ensuing price dynamics can be described as a fire sale. The proposed framework can assess five different policy options that officials have advocated for combating defaults, credit crunches and fire sales, namely: limits on loan to value ratios, capital requirements for banks, liquidity coverage ratios for banks, dynamic loan loss provisioning for banks, and margin requirements on repurchase agreements used by shadow banks. The paper aims to develop some general intuition about the interactions between the tools and to determine whether they act as complements and substitutes.
Number of Pages in PDF File: 53
Keywords: Price setting, changeover, euro, inflation
JEL Classification: E31, F33, M39working papers series
Date posted: April 5, 2012
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