Macroeconomic Propagation under Different Regulatory Regimes: Evidence from an Estimated DSGE Model for the Euro Area

This article analyzes the role of credit market frictions in business-cycle fluctuations and in the transmission of monetary policy. We estimate a closed-economy dynamic stochastic general equilibrium (DSGE) model for the euro area with financially constrained households and firms and embedding an oligopolistic banking sector facing capital constraints. Using this setup we examine the monetary policy implications of the various financial frictions to credit supply and demand and furthermore examine the real economic implications of increasing capital requirements and of introducing risk-sensitive capital requirements. Moreover, the potential for introducing counter-cyclical bank capital rules and aligning macroprudential tools with standard monetary policy tools is examined. In particular, the model results highlight the importance of operating with a protracted implementation schedule of new regulatory requirements for smoothing out the transitional costs to the economy arising from a more capital-constrained banking sector.