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GROWTH AND WELFARE EFFECTS OF MACROPRUDENTIAL REGULATION

Published online by Cambridge University Press:  07 February 2018

Pierre-Richard Agénor
Pierre-Richard Agénor*
Affiliation:
University of Manchester
*
Address correspondence to: Pierre-Richard Agénor, Arthur Lewis Building, School of Social Sciences, Oxford Road, Manchester M13 9PL, United Kingdom; e-mail: pierre-richard.agenor@manchester.ac.uk
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Abstract

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This paper studies the growth and welfare effects of macroprudential regulation in an overlapping generations model of endogenous growth with banking and agency costs. Indivisible investment projects combine with informational imperfections to create a double moral hazard problem à la Holmström–Tirole and a role for bank monitoring. When the optimal monitoring intensity is endogenously determined, an increase in the required reserve ratio (motivated by systemic risk considerations) has conflicting effects on investment and growth. On one hand, requiring banks to put away a fraction of the deposits that they receive reduces the supply of loanable funds. On the other, a higher required ratio raises incentives to save and mitigates banks' incentives to monitor, thereby lowering monitoring costs and freeing up resources to increase lending. In addition, it may mitigate the systemic risk externality associated with excessive leverage. This trade-off can be internalized by choosing the required reserve ratio that maximizes growth and welfare. However, the risk of disintermediation means that in practice financial supervision may also need to be strengthened, and the perimeter of regulation broadened, if the optimal ratio is relatively high.

Keywords

Prudential RegulationReserve RequirementsBank MonitoringGrowthWelfare

Information

Type
Articles
Information
Macroeconomic Dynamics , Volume 23 , Issue 8 , December 2019, pp. 3140 - 3162
Copyright
Copyright © Cambridge University Press 2018 

Footnotes

School of Social Sciences, University of Manchester, United Kingdom, and Centre for Growth and Business Cycle Research. I am grateful to participants at various seminars and conferences, and especially the Associate Editor and two anonymous referees, for many helpful comments. King Yoong Lim provided able research assistance. Financial support from the DFID-ESRC Growth Research Programme, under Grant no. ES/L012022/1, is gratefully acknowledged. The views expressed in this paper are my own.

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