The financial crisis of 2007- 2009 pointed out the central importance of banks in the macroeconomy and how their financial weakness quickly spreads out and spills over into the real economy. In the pre-crisis context, excessive leverage and reliance on short-term wholesale funding made banks very exposed to liquidity risk. During the financial crisis, banks got trapped in an adverse liquidity spiral: assets lost value, banks faced higher margins and haircuts on their short-term borrowing, making it increasingly difficult for them to roll-over their debt, and forcing them to sell their assets, which would then further depress asset prices. Following the financial crisis, Basel III introduced liquidity regulation for banks, aiming at making the banking sector more resilient to liquidity stress. The impact of bank liquidity regulation on aggregate variables such as output, credit, investment, consumption and asset prices, is uncertain. The aim of this project is to analyze liquidity regulation from a macroeconomic perspective, using models that capture the links between the financial sector and the real economy.
Collaborators
Corinne Dubois