Financial Regulation, Credit and Liquidity Policy and the Business Cycle

The global …nancial crisis in 2007 prompted policy makers to introduce a combi- nation of bank regulation and macroprudential policies, including non-conventional monetary policies, such as interest on reserves and changes in required reserves. This paper examines how the combination of such policies can help stabilize the eects of real and …nancial shocks in economies where …nancial frictions are impor- tant. Although there is an extensive literature on …nancial regulation and macro- prudiential policy, and more recently some literature on the eects of interest on reserves, these policies are usually examined independently. The results point to the importance of coordination between …nancial regulation and monetary policy in minimizing welfare losses following such shocks. Interest on reserves is shown to be more eective in reducing welfare losses than changes in required reserves and to play a signi…cant role in making stabilization policy more eective. The results also suggest an easing of bank capital requirements during recessions, when output and loans are falling and the risk of default is high.