Comparing the Impacts of Financial Regulation in Australia and the United States via Simulation with Country-Specific Financial CGE Models
62 Pages Posted: 22 Jun 2016
Date Written: June 19, 2016
Beginning with [Johansen (1960)], computable general equilibrium (CGE) models have been widely applied to study the impact of a variety of economic policy issues. These include changes in macroeconomic or regional economic policies such as tariff reductions, changes in labour force demographics and skill levels, the impact of epidemics and terrorist attacks, the impact of drought and water policy reform, and the economic costs of climate change mitigation (Dixon and Parmenter (1996); Dixon and Rimmer (2002); Adams (2007); Giesecke et al. (2015); Wittwer and Dixon (2015)). Despite the efficacy of CGE models as tools in policy analysis, key linkages between the real and financial economies are often treated implicitly; for example, the current account deficit is assumed to be financed in full by a foreign agent, e.g., via a small country assumption. In an explicit sense we may ask how the foreign investor chooses to finance a deficit, e.g., do they prefer to purchase domestic agent bonds, equity or a combination of the two instruments? What are the associated implications for relative rates-of-return across the suite of domestic financial instruments, and how do changes in relative returns impact domestic agent investment decisions, nominal exchange rates, and the real economy? This paper seeks to address such questions via the development of a theory of the financial sector for a traditional dynamic CGE model of the U.S. (USAGE 2.0). We begin with a brief synopsis of the construction of a financial database for the United States (U.S.), which documents the stocks and transactional flows of 5 financial and nonfinancial instruments across 11 distinct agents. The financial database derived herein and the approach documented in Dixon et al. (2015), are then used to develop a new financial CGE model of the U.S. called USAGE2F. Explicit recognition of financial stocks and flows broadens the scope of CGE analyses to include the effects of changes in capital adequacy requirements of key financial agents, e.g., the commercial banks, as we illustrate with an example. The results are subsequently compared to findings of a similar policy scenario in Australia, which are outlined in Giesecke et al. (2016). This analysis serves to illustrate how the impacts of regulatory change (in this case, a rise in capital adequacy ratios) can be affected by jurisdiction-specific differences in the structure of the financial sector.
Keywords: Capital adequacy ratio, financial stability, financial CGE model
JEL Classification: E17, E44, G21, C68
Suggested Citation: Suggested Citation