Working Paper: CEPR ID: DP15001
Authors: Eric Monnet; Miklos Vari
Abstract: History suggests a conflict between current Basel III liquidity ratios and monetary policy,which we call the liquidity regulation dilemma. Although forgotten, liquidity ratios, named“securities-reserve requirements”, were widely used historically, but for monetary policy (notregulatory) reasons, as central bankers recognized the contractionary effects of these ratios.We build a model rationalizing historical policies: a tighter ratio reduces the quantity of assetsthat banks can pledge as collateral, thus increasing interest rates. Tighter liquidity regulationparadoxically increases the need for central bank’s interventions. Liquidity ratios were alsoused to keep yields on government bonds low when monetary policy tightened
Keywords: liquidity ratios; reserve requirements; Basel III; monetary policy implementation; liquidity coverage ratio (LCR); central bank history
JEL Codes: E43; E52; E58; G28; N10; N20
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| tighter liquidity ratios (E51) | increased interest rates (E43) |
| increased interest rates (E43) | central bank interventions (E58) |
| tighter liquidity ratios (E51) | increased demand for central bank liquidity (E51) |
| liquidity ratios historically influenced money market rates (E43) | stabilize output and inflation (E63) |
| liquidity ratios functioned as collateral constraints (G33) | maintaining low yields on government bonds (E43) |