Financial Regulation and Endogenous Macroeconomic Crises

Abstract

We explore the effects of banking regulation on financial stability and macroeconomic dynamics in an agent-based computational model. In particular, we study the minimum level of capital and the lending concentration towards a single counterpart. We show that an overly tight regulation is dangerous because it reduces credit availability. By contrast, overly loose constraints, associated with a high payout ratio, increase financial fragility that, in turn, damage the real economy. Simulation results support the introduction of regulatory rules aimed at assuring an adequate capitalization of banks, such as the Capital Conservation Buffer (Basel III reform)

Agent-Based Macroeconomics

“…This observation highlights the importance of taking into account the details of the underlying macroeconomic setup when interpreting the qualitative insights from policy analyses. Riccetti et al (2017) employ still another agent-based macroeconomic framework and show that, similarly to the finding reported above, also in their setting a too loose capitalbased banking regulation increases financial fragility with potential negative implications for the real economy. However, they also point out that an overly tight regulation, which restricts the availability of credit too strongly, is detrimental for the performance of the economy.…”

“…A medium-to large model (so called "modellone") is an extension of the previous framework: Riccetti et al (2015). For applications of this model to different topics, see Riccetti et al (2013), Riccetti et al (2016a), Russo et al (2016), Riccetti et al (2018). Caiani et al (2016a) develop a medium-to large model with emphasis on stock-flow consistency (so called "modellaccio").…”

Agent-Based Macroeconomics and Classical Political Economy: Some Italian Roots

“…Indeed, the simultaneous reduction in banks' equity and firms' net worth increase both the reliance of credit of the latter and their possibility of being credit rationed, thus increasing the financial fragility of the economy. Relatedly, in presence of higher banking deregulation, the introduction of a counter-cyclical capital buffer as in the Basel III macroprudential regulation can reduce the financial fragility of the system, thus dampening output volatility and the occurrence of economic crises (Riccetti et al, 2017). 15 Finally, monetary policy strategies have been studied in Giri et al (2016).…”

Monetary Policy and Large Crises in a Financial Accelerator Agent-Based Model

“…Delli Gatti et al (2005) explore the role of monetary policy in a complex system with agent's learning; Russo et al (2007) focus on fiscal policy and its effect on R&D dynamics; Haber (2008) investigates the effect of both fiscal and monetary policies; Cincotti et al (2010Cincotti et al ( , 2012a Riccetti et al (2016) explore the effects of banking regulation on financial stability and endogenous macroeconomic crises. All in all, ABMs represent an alternative approach for studying a complex macroeconomy that may highlight relevant implications for economic policy design (Dawid and Neugart, 2011 Another fundamental issue is the way in which financial factors are included into a macroeconomic model that is strictly related to the problem of replicating, at least qualitatively, the dynamic evolution of the spread between the lending rates and the policy rate.…”