Slow recoveries, endogenous growth and macroprudential 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 macroprudential 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 macroprudential policy are even more significant.

Keywords: Slow recoveries, endogenous growth, financial stability, macroprudential policy

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