Bank Procyclicality, Credit Crunches, and Asymmetric Monetary Policy Effects: A Unifying Model

Perceived credit crunches, excessive procyclicality in bank behavior, and limited effectiveness of expansionary Fed monetary policy in economic recessions are not easily predicted by the usual simple textbook bank deposit or bank credit expansion model as outcomes of an expansive monetary policy. Bu...

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Bibliographic Details
Published in:Journal of applied finance : JAF 2003-10, Vol.13 (2), p.23
Main Authors: Bliss, Robert R, Kaufman, George G
Format: Article
Language:English
Subjects:
Balance sheets
Bank deposits
Bank earnings
Bank reserves
Banking industry
Business cycles
Capital requirements
Central banks
Economic models
Equilibrium
Federal Reserve monetary policy
Interest rates
Loans
Macroeconomics
Monetary policy
Recessions
Regulation of financial institutions
Reserve requirements
Textbooks
Volatility
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Summary:Perceived credit crunches, excessive procyclicality in bank behavior, and limited effectiveness of expansionary Fed monetary policy in economic recessions are not easily predicted by the usual simple textbook bank deposit or bank credit expansion model as outcomes of an expansive monetary policy. But, with a relatively simple modification to this model that introduces a market or regulatory capital constraint in addition to the traditional reserve constraint, it is demonstrated that all 3 effects may be predictable outcomes. Where capital requirements are binding, the model clearly shows that injection of additional reserves by the Fed may not achieve the intended increase in bank deposits and earning assets. If either constraint is binding, earning assets cannot grow further. Observed fluctuations in the level of bank capital through the business cycle-higher capital ratios during economic expansions and lower ratios during recessions-together with changes in the effective capital requirement if the ratio is risk-sensitive, are likely to create further procyclical changes in bank loans and earning assets and give rise to perceived credit crunches.
ISSN:1534-6668