Abstract
Prudential bank regulation complicates monetary policy because it has cyclical effects on the growth of bank credit, which can be a channel through which monetary policy is transmitted to the economy. Employing a panel of 36 advanced and developing countries for the period 1973-2015, we find that changes in regulation have been procyclical with respect to credit surges and counter-cyclical with respect to credit stops. As a result, monetary policy risks being too loose over the credit cycle. The economic effects of prudential regulation on credit have been meaningful given the large-scale bank liberalizations undertaken by many countries. The result is robust to dealing with a wide range of sensitivity tests and endogeneity concerns. In designing regulations, policymakers need to consider transmission mechanisms through which they might affect the real economy and undermine the goals of monetary policy.
Original language | English |
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Journal | Journal of Financial Stability |
Early online date | 25 May 2023 |
DOIs | |
Publication status | E-pub ahead of print - 25 May 2023 |
Keywords
- Prudential regulation
- Credit surge
- Credit stop
- Probit
- Endogeneity