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Unconventional Monetary Policy and the Safety of the Banking System

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  • Martine Quinzii

    (University of California, Davis)

Abstract

This paper presents a simple model of banking equilibrium in which unconventional monetary policy serves as a tool to enhance the safety of the banking system. Every economy has two intrinsic characteristics: a ``natural'' debt-equity ratio which depends on the endowments of the infinitely risk averse safe-debt providers and the risk neutral equity providers, and a ``critical'' debt-equity ratio which depends only on the risks inherent in the banks' productive loans. When the natural debt-equity ratio exceeds the critical ratio, there is a positive probability of bankruptcy in equilibrium. In such ``high debt'' economies, standard banking equilibria are inefficient regardless of the capital requirement imposed by regulators. However unconventional monetary policy using the balance sheet of the Central Bank in conjunction with a standard equity requirement can restore the Pareto optimality of the banking equilibrium.

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  • Martine Quinzii, 2016. "Unconventional Monetary Policy and the Safety of the Banking System," 2016 Meeting Papers 1511, Society for Economic Dynamics.
    • Handle: RePEc:red:sed016:1511
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    References listed on IDEAS

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    Cited by:

    1. N Aaron Pancost & Roberto Robatto & Itay Goldstein, 2023. "The Effects of Capital Requirements on Good and Bad Risk-Taking," The Review of Financial Studies, Society for Financial Studies, vol. 36(2), pages 733-774.
    2. Benigno, Pierpaolo & Robatto, Roberto, 2019. "Private money creation, liquidity crises, and government interventions," Journal of Monetary Economics, Elsevier, vol. 106(C), pages 42-58.
    3. Jaevin Park, 2020. "Inside Money, Business Cycle, and Bank Capital Requirements," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 36, pages 103-121, April.

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