Abstract
Commercial banks across the world have been implementing the Basel III accord, which is the most important international response to the 2007-2008 financial crisis. Particularly, the Liquidity Coverage Ratio (LCR) introduced by the Basel III accord is the first global standard for banking liquidity management. Does this requirement work? And what macroeconomic effects does it produce? In order to address such crucial issues, we develop a stock-flow consistent (SFC)/agent-based computational economic (ACE) model. As we know, there is a real danger that the requirement restricts the availability of bank credit and hence reducing economic activity. However, in comparison to the prior works, we find that the externality is presented as a positive self-reinforcing feedback process, which causes the macroeconomic conditions to spiral downwards. This dynamic feedback process that hardly can be revealed by the current macroeconomic models based on equilibrium analyses. Our results also shed some light on the fact that credit creation substantially affects economic activity and macroeconomic stability, as the fundamental reason leading to our results. Therefore, the bank as the driver of credit creation is crucial in an economy, and meanwhile bank regulations have great potential impacts on entire economy rather than only in the bank sector itself.
Highlights
The 2007-2008 financial crisis drags the global economy into a deep and longlasting recession
As we said in Introduction, we are mainly concerned with how the bank sector complying with the Liquidity Coverage Ratio (LCR) affects macroeconomic conditions
In order to emphasize the effects of the feedback, we provide the contrasts between the feedback effects resulted from the LCR and the benchmark scenario in which the bank constantly holds an average buffer of the actual buffers of the 30 periods from the time point of increasing the LCR, i.e., the feedback process is eliminated, ceteris paribus
Summary
The 2007-2008 financial crisis drags the global economy into a deep and longlasting recession Despite those multiple possible causes of the crisis explored by a series of prominent works, e.g., financial deregulation (Crotty, 2009), loose monetary policy (Taylor, 2009), global imbalances (Obstfeld and Rogoff, 2009), misperception of risk (Baily et al, 2011); there should be little debate with the main origin of this disaster: the excessive credit created by the banking systems (Acharya and Richardson, 2009; Farhi and Tirole, 2012; Kashyap et al, 2008; Liikanen, 2012; Schularick and Taylor, 2012; Stiglitz, 2009; Vickers, 2011).
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