Monetary Policy Amplification Effects through a Bank Capital Channel

Abstract

This paper improves the analysis of the role of financial frictions in the transmission of monetary policy, by bringing together the borrowers' balance sheet channel with an additional channel working through bank capital, considering capital adequacy regulations and households' preferences for liquidity. Detailing a dynamic new Keynesian general equilibrium model, in which households require a (countercyclical) liquidity premium to hold bank capital, we find that the introduction of bank capital amplifies monetary shocks to the macroeconomy through a liquidity premium effect on the external finance premium. This effect, together with the financial accelerator, generates quantitatively large amplification effectsBank capital channel; Bank capital requirements; Financial accelerator; Liquidity premium; Monetary transmission mechanism