Monetary Policy and Anti‐Cyclical Bank Capital Regulation

22 Pages Posted: 22 Feb 2018

See all articles by Roger A Aliaga-Diaz

Roger A Aliaga-Diaz

The Vanguard Group, Inc.

Maria P Olivero

Drexel University

Andrew Powell

Inter-American Development Bank (IDB); Universidad Torcuato Di Tella - School of Business; Harvard University - Center for International Development (CID)

Date Written: April 2018

Abstract

The financial crisis of 2008–2009 revived attention given to booms and busts in bank credit, and their effects on real activity. This interest sparked two different strands of research in macro. The first one focuses on monetary policy in the context of financial frictions. The second studies capital regulation in banking. To the best of our knowledge, so far these two topics have mostly been studied in isolation from each other. Thus, we still lack an understanding of how monetary policy and bank capital regulation interact in the presence of financial fragility. This paper aims to contribute to furthering this understanding. Specifically, we ask how the monetary policy rule should look like in the presence of cyclical capital requirements. We extend the dynamic stochastic general equilibrium model with bank capital in Aliaga‐Díaz and Olivero by introducing price rigidities in the spirit of the New‐Keynesian literature. We find that: First, anti‐cyclical requirements have important stabilization properties relative to the case of constant requirements. This is true for all types of fluctuations that we study, which include those caused by productivity, preference, fiscal, monetary, and financial shocks. Second, output and consumption volatilities present in the no regulation economy can be recovered with anti‐cyclical requirements as long as the policy rate responds only slightly to credit spreads. Third, monetary policy rules that respond to credit conditions also perform better in terms of welfare.

JEL Classification: E32, E44

Suggested Citation

Aliaga-Diaz, Roger A and Olivero, Maria P and Powell, Andrew P. and Powell, Andrew P., Monetary Policy and Anti‐Cyclical Bank Capital Regulation (April 2018). Economic Inquiry, Vol. 56, Issue 2, pp. 837-858, 2018, Available at SSRN: https://ssrn.com/abstract=3127882 or http://dx.doi.org/10.1111/ecin.12501

Roger A Aliaga-Diaz (Contact Author)

The Vanguard Group, Inc. ( email )

100 Vanguard Blvd
Malvern, PA 19355
United States

Maria P Olivero

Drexel University

Andrew P. Powell

Universidad Torcuato Di Tella - School of Business ( email )

Saenz Valiente 1010
C1428BIJ Buenos Aires
Argentina
+5411 4787-9349 (Phone)
+5411 4783-3220 (Fax)

Inter-American Development Bank (IDB) ( email )

1300 New York Avenue NW
Washington, DC 20577
United States

Harvard University - Center for International Development (CID) ( email )

One Eliot Street Building
79 JFK Street
Cambridge, MA 02138
United States

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