Financial Regulation in General Equilibrium

50 Pages Posted: 6 Mar 2012 Last revised: 4 Apr 2013

See all articles by Charles Goodhart

Charles Goodhart

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); Federal Reserve Bank of Chicago

Dimitrios P. Tsomocos

University of Oxford - Said Business School and St. Edmund Hall

Alexandros Vardoulakis

Board of Governors of the Federal Reserve System

Multiple version iconThere are 3 versions of this paper

Date Written: March 1, 2012

Abstract

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.

Suggested Citation

Goodhart, Charles A.E. and Kashyap, Anil K. and Tsomocos, Dimitrios P. and Vardoulakis, Alexandros, Financial Regulation in General Equilibrium (March 1, 2012). Chicago Booth Research Paper No. 12-11, Fama-Miller Working Paper, Available at SSRN: https://ssrn.com/abstract=2016209 or http://dx.doi.org/10.2139/ssrn.2016209

Charles A.E. Goodhart

London School of Economics & Political Science (LSE) - Financial Markets Group ( email )

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Anil K. Kashyap (Contact Author)

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Dimitrios P. Tsomocos

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Alexandros Vardoulakis

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