Bank Recapitalizations, Credit Supply, and the Transmission of Monetary Policy
53 Pages Posted: 19 Dec 2018
Date Written: December 17, 2018
We integrate a banking sector in a standard New-Keynesian DSGE model, and examine how government policies to recapitalize banks after a crisis affect the supply of credit and the transmission of monetary policy. We examine two types of recapitalizations: immediate and delayed ones. In the steady state, both policies cause the banking sector to charge inefficiently low lending rates, which leads to an inefficiently large capital stock. Raising bank equity requirements reduces this dynamic inefficiency and increases lifetime utility. After the banking sector suffered large losses, a delay in recapitalizations creates banking sector debt-overhang. This debt-overhang leads to inefficiently high lending rates, which reduces the supply of credit and weakens the transmission of monetary policy to inflation (the transmission to output is largely unchanged). Raising bank equity requirements under these circumstances can cause lifetime utility to decline. Hence, the timing of bank recapitalizations after a crisis has several macro-economic implications.
Keywords: bank recapitalizations, credit supply, monetary policy transmission, bank equity requirements, NK-DSGE models
JEL Classification: E30, E44, E52, E61
Suggested Citation: Suggested Citation