Slow Recoveries, Endogenous Growth and Macro-prudential Policy

Abstract

Banking crises have severe short and long-term consequences. We develop a general equilibrium
model with financial frictions and endogenous growth in which macro-prudential policy
supports economic activity and productivity growth by strengthening bank’s resilience
to adverse financial shocks. The improved intermediation capacity of a safer banking system
leads to a higher steady state growth rate. The optimal bank capital ratio of 18% increases
welfare by 6.7%, 14 times more than in the case without endogenous growth. When the
economy enters a liquidity trap, the effects of financial disruptions and thus the benefits of
macro-prudential policy are even more significant.

Keywords: Slow Recoveries, Endogenous Growth, Financial Stability, Macroprudential Policy

JEL Classification: E32, E44, E52, G01, G18