Macro-Prudential Policy on Liquidity: What Does a DSGE Model Tell Us?

41 Pages Posted: 3 May 2011 Last revised: 1 Jul 2011

See all articles by Jagjit S. Chadha

Jagjit S. Chadha

University of St. Andrews - School of Management

Luisa Corrado

University of Rome Tor Vergata Department of Economics and Finance

Date Written: December 2, 2010

Abstract

The financial crisis has led to the development of an active debate on the use of macro-prudential instruments for regulating the banking system, in particular for liquidity and capital holdings. Within the context of a micro-founded macroeconomic model, we allow commercial banks to choose their optimal mix of asset creation, apportioning this to either reserves or private sector loans. We examine the implications for quantities, relative non-financial and financial prices from standard macroeconomic shocks alongside shocks to the expected liquidity of banks and to the efficiency of the banking sector. We focus on the response by the monetary sector, in particular the optimal reserve-deposit ratio adopted by commercial banks. Overall we find some rationale for Basel III in providing commercial banks with an incentive to hold liquid assets, such as reserves, as this acts to limit the procyclicality of lending to the private sector.

Keywords: Liquidity, interest on reserves, policy instruments, Basel

JEL Classification: E31, E40, E51

Suggested Citation

Chadha, Jagjit S. and Corrado, Luisa, Macro-Prudential Policy on Liquidity: What Does a DSGE Model Tell Us? (December 2, 2010). CEIS Working Paper No. 193. Available at SSRN: https://ssrn.com/abstract=1829084 or http://dx.doi.org/10.2139/ssrn.1829084

Jagjit S. Chadha

University of St. Andrews - School of Management ( email )

The Gateway
Gateway
St. Andrews, Fife KY16 9SS
United Kingdom
+44 1334 462440 (Phone)

HOME PAGE: http://www.st-andrews.ac.uk/economics/staff/pages/j.chadha.shtml

Luisa Corrado (Contact Author)

University of Rome Tor Vergata Department of Economics and Finance ( email )

Via Columbia n.2
Rome, rome 00100
Italy

Register to save articles to
your library

Register

Paper statistics

Downloads
152
Abstract Views
821
rank
191,138
PlumX Metrics