The effects of countercyclical leverage buffers on macroeconomic and financial stability

Abstract

We quantitatively study the effectiveness of several target variables for countercyclical leverage buffers in promoting macroeconomic and financial stability. To do this we introduce banks and a regulatory leverage requirement rule to a DSGE model. The capital requirement consists of a fixed part and a countercyclical part. We find that the tighter the fixed leverage requirement, the better able banks are to handle a financial crisis, but these also reduce long-term consumption and welfare. More importantly, countercyclical leverage buffers that respond to deviation of the observed credit to GDP ratio from its long-term value, or to percentage deviation of the observed credit (or GDP) from its long-term value improve macroeconomic and financial stability and increase welfare. Being forward-looking does not pay off. Interestingly, when buffers respond to the percentage deviation of asset prices from their long-term values or to credit (or GDP) growth, macroeconomic and financial stability is negatively affected.