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Liquidity Rules and Credit Booms

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  • Kinda Cheryl Hachem
  • Zheng Michael Song

Abstract

This paper shows that liquidity regulation can trigger unintended credit booms in the presence of interbank market power. We consider a price-setter and a continuum of price-takers who trade reserves after the realization of idiosyncratic liquidity shocks. The price-takers are endogenously less liquid and circumvent regulation by engaging in shadow banking, which leads to a reallocation of funding away from the more liquid price-setter. This reallocation channel underlies the credit boom. Endogenous responses in bank liquidity ratios also affect the magnitude of the boom. We discuss extensions of the model and illustrate its quantitative performance with an application to China.

Suggested Citation

  • Kinda Cheryl Hachem & Zheng Michael Song, 2016. "Liquidity Rules and Credit Booms," NBER Working Papers 21880, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:21880
    Note: CF EFG ME
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    References listed on IDEAS

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    1. Chang-Tai Hsieh & Zheng (Michael) Song, 2015. "Grasp the Large, Let Go of the Small: The Transformation of the State Sector in China," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 50(1 (Spring), pages 295-366.
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    6. Gorton, Gary & Metrick, Andrew, 2012. "Securitized banking and the run on repo," Journal of Financial Economics, Elsevier, vol. 104(3), pages 425-451.
    7. Brandt, Loren & Van Biesebroeck, Johannes & Zhang, Yifan, 2012. "Creative accounting or creative destruction? Firm-level productivity growth in Chinese manufacturing," Journal of Development Economics, Elsevier, vol. 97(2), pages 339-351.
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    10. Chang-Tai Hsieh & Zheng (Michael) Song, 2015. "Grasp the Large, Let Go of the Small: The Transformation of the State Sector in China," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 46(1 (Spring), pages 295-366.
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    More about this item

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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