Financial Regulation, Credit and Liquidity Policy and the Business Cycle

The global financial crisis in 2007 prompted policy makers to introduce a combination of bank regulation and macroprudential policies, including non-conventional monetary policies, such as interest on reserves and changes in required reserves. This paper examines how the combination of such policies can help stabilize the effects of real and financial shocks in economies where financial frictions are important. Although there is an extensive literature on financial regulation and macro-prudential policy, and more recently some literature on the effects of interest on reserves, these policies are usually examined independently. The results point to the importance of coordination between financial regulation and monetary policy in minimizing welfare losses following such shocks. Interest on reserves is shown to be more effective in reducing welfare losses than changes in required reserves and to play a significant role in making stabilization policy more effective. The results also suggest an easing of bank capital requirements during recessions, when output and loans are falling and the risk of default is high

Pandemic Shocks and Macroprudential Policy

We introduce an extended borrower-saver DSGE model, where based on the Kaplan et al. (2020) classification of occupations, agents are split further into two subcategories, according to whether their occupation is directly ‘affected’ by a pandemic shock. We find that, contrary to the standard literature, during a pandemic shock an increase in the LTV ratio can increase social welfare and make all four agent types (borrowers affected, borrowers non-affected, savers affected, and savers non-affected) better off. Countercyclical optimal LTV rules are shown to increase social welfare, with savers gaining at the expense of borrowers, including those mostly affected by the pandemic. An interest rate mortgage subsidy to those worst affected (‘affected’ mortgage borrowers), in coordination with stricter monetary and LTV policy, are shown to increase both social welfare and the welfare of borrowers and savers affected by the pandemic

Precautionary Liquidity Shocks, Excess Reserves and Business Cycles

This paper identifies a precautionary banking liquidity shock via a set of sign, zero and forecast variance restrictions imposed. The shock proxies the banking sector’s reluctance to lend to the real economy induced by an exogenous preference change for liquid assets. Through the lens of a DSGE model, the precautionary liquidity shock is shown to work through two channels: reserves (balance sheet) and the deposit rate (intertemporal effect). The overall effect is a downward co-movement in output, consumption, investment, and prices, which is amplified the higher are the long-run risks in the economy and banks’ responsiveness to potential risk