The ‘new normal’ during normal times – liquidity regulation and conventional monetary policy
Gepubliceerd: 07 januari 2021
We analyze the impact of a requirement similar to the Basel III Liquidity Coverage Ratio (LCR) on conventional monetary policy implementation. Combining unique data sets of Dutch banks from 2002 to 2005, we find that the introduction of the LCR impacts banks’ behaviour in open market operations. After the introduction of the LCR, banks bid for higher volumes and pay higher interest rates for central bank funds. In line with theory, banks reduce their reliance on overnight and short term unsecured funding. We do not observe a worsening of collateral quality pledged in open market operations. Thus, to correctly anticipate an open market operation’s effect on interest rates, monetary policy requires central banks to consider not only the size of the operation, but also how it impacts banks’ liquidity management and compliance with the LCR.
Keywords: Liquidity regulation; monetary policy implementation; financial intermediation; banks; open market operations
JEL codes G18; G21; E42
Working paper no. 703
nr. 703 - The ‘new normal’ during normal times – liquidity regulation and conventional monetary policy
Research Highlights
- In this paper, we analyze how corporate income tax shocks affect labor productivity and business dynamism in the Unites States.
- In the empirical analysis we use both aggregate data, in a vector autoregression (VAR) framework, and exploit variations in state-level corporate income taxes across US states.
- We find that an unexpected cut in the corporate tax rate has immediate beneficial effects on productivity, GDP, and pre-tax profits. Also, it leads to a delayed surge in entry, and to an increase in exit of firms from the market.
- Exploiting a New Keynesian general equilibrium model with endogenous firm entry and exit, we find that selection and cleansing effects are paramount to capture the dynamic effects of corporate tax cuts identified in the data.
- Further, we show that the critical nominal friction to address the empirical responses of productivity and profits to a tax shock is wage contracts, not price contracts.
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