Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/203101 
Year of Publication: 
2019
Series/Report no.: 
LEM Working Paper Series No. 2019/11
Publisher: 
Scuola Superiore Sant'Anna, Laboratory of Economics and Management (LEM), Pisa
Abstract: 
We develop a macroeconomic agent-based model to study how financial instability can emerge from the co-evolution of interbank and credit markets and the policy responses to mitigate its impact on the real economy. The model is populated by heterogenous firms, consumers, and banks that locally interact in different markets. In particular, banks provide credit to firms according to a Basel II or III macro-prudential frameworks and manage their liquidity in the interbank market. The Central Bank performs monetary policy according to different types of Taylor rules. We find that the model endogenously generates market freezes in the interbank market which interact with the financial accelerator possibly leading to firm bankruptcies, banking crises and the emergence of deep downturns. This requires the timely intervention of the Central Bank as a liquidity lender of last resort. Moreover, we find that the joint adoption of a three mandate Taylor rule tackling credit growth and the Basel III macro-prudential framework is the best policy mix to stabilize financial and real economic dynamics. However, as the Liquidity Coverage Ratio spurs financial instability by increasing the pro-cyclicality of banks' liquid reserves, a new counter-cyclical liquidity buffer should be added to Basel III to improve its performance further. Finally, we find that the Central Bank can also dampen financial instability by employing a new unconventional monetary-policy tool involving active management of the interest-rate corridor in the interbank market.
Subjects: 
financial instability
interbank market freezes
monetary policy
macro-prudential policy
Basel III regulation
Tinbergen principle
agent-based models
JEL: 
C63
E52
E6
G01
G21
G28
Document Type: 
Working Paper

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