Do Capital Adequacy Requirements Matter for Monetary Policy?

35 Pages Posted: 2 Mar 2006

See all articles by Stephen G. Cecchetti

Stephen G. Cecchetti

Brandeis International Business School; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Lianfa Li

China International Capital Corporation

Multiple version iconThere are 2 versions of this paper

Date Written: December 2005

Abstract

Central bankers and financial supervisors often have different goals. While monetary policymakers want to ensure that there are always sufficient lending activities to maintain high and stable economic growth, supervisors work to limit banks. lending capacities in order to prevent excessive risk-taking. To avoid working at cross-purposes, central bankers need to adopt a policy strategy that accounts for the impact of capital adequacy requirements. In this paper we derive an optimal monetary policy that reinforces prudential capital requirements at the same time that it stabilizes aggregate economic activity. We go on to show that policymakers at the Federal Reserve adjust interest rate policy in a way that would neutralize the procyclical impact of bank capital requirements. By contrast, central bankers in Germany and Japan clearly do not act as the theory suggests they should.

Suggested Citation

Cecchetti, Stephen G. and Li, Lianfa, Do Capital Adequacy Requirements Matter for Monetary Policy? (December 2005). NBER Working Paper No. w11830. Available at SSRN: https://ssrn.com/abstract=875706

Stephen G. Cecchetti (Contact Author)

Brandeis International Business School ( email )

415 South Street
Waltham, MA 02453
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States
212-720-8629 (Phone)
212-720-2630 (Fax)

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Lianfa Li

China International Capital Corporation ( email )

28th Floor, China World Tower 2
No. 1 Jian Guo Men Wai Avenue
Beijing 100004
China

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