Liquidity Rules and Credit Booms / Kinda Cheryl Hachem, Zheng Michael Song.

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Hachem, Kinda Cheryl

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Material type: Text

TextSeries: Working Paper Series (National Bureau of Economic Research) ; no. w21880.Publication details: Cambridge, Mass. National Bureau of Economic Research 2016.Description: 1 online resource: illustrations (black and white)Subject(s):

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Abstract: This paper shows that liquidity regulation can trigger unintended credit booms in the presence of interbank market power. We consider a price-setter and a continuum of price-takers who trade reserves after the realization of idiosyncratic liquidity shocks. The price-takers are endogenously less liquid and circumvent regulation by engaging in shadow banking, which leads to a reallocation of funding away from the more liquid price-setter. This reallocation channel underlies the credit boom. Endogenous responses in bank liquidity ratios also affect the magnitude of the boom. We discuss extensions of the model and illustrate its quantitative performance with an application to China.

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Previous	nber w21878 International Coordination /	nber w21879 Credit-Market Sentiment and the Business Cycle /	nber w2188 Money, Imperfect Information and Economic Fluctuations /	nber w21880 Liquidity Rules and Credit Booms /	nber w21881 Colonial Virginia's Paper Money Regime, 1755-1774: Value Decomposition and Performance /	nber w21882 Immigration in American Economic History /	nber w21883 Global Supply Chains and Trade Policy /	Next

January 2016.

This paper shows that liquidity regulation can trigger unintended credit booms in the presence of interbank market power. We consider a price-setter and a continuum of price-takers who trade reserves after the realization of idiosyncratic liquidity shocks. The price-takers are endogenously less liquid and circumvent regulation by engaging in shadow banking, which leads to a reallocation of funding away from the more liquid price-setter. This reallocation channel underlies the credit boom. Endogenous responses in bank liquidity ratios also affect the magnitude of the boom. We discuss extensions of the model and illustrate its quantitative performance with an application to China.