Modeling Two Macro Policy Instruments - Interest Rates and Aggregate Capital Requirements
26 Pages Posted: 5 Oct 2011
Date Written: September 30, 2011
We present a simple neoclassical model to explore how an aggregate bank-capital requirement can be used as a macroeconomic policy tool and how this additional tool interacts with monetary policy. Aggregate bank-capital requirements should be adjusted when the economy is hit by cost-push shocks but should not respond to demand shocks. Moreover, an optimal institutional structure is characterized as follows: First, monetary policy is delegated to an independent and conservative central banker. Second, setting aggregate bank-capital requirements is separated from monetary policy.
Keywords: central banks, banking regulation, capital requirements, optimal monetary policy
JEL Classification: E520, E580, G280
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