Interbank Market and Macroprudential Tools in a DSGE Model

Abstract

The interbank market helps regulate liquidity in the banking sector. Banks with outstanding resources usually lend to banks that are in needs of liquidity. Regulating the interbank market may actually benefit the policy stance of monetary policy. Introducing an interbank market in a general equilibrium model may allow better identification of the final effects of non-conventional policy tools such as reserve requirements. We introduce an interbank market in which there are two types of private banks and a central bank that has the ability to issue money into a DSGE model. Then, we use the model to analyse the effects of changes to reserve requirements (a macroprudential tool), while the central bank follows a Taylor rule to set the policy interest rate. We find that changes to reserve requirements have similar effects to interest rate hikes and that both monetary policy tools can be used jointly in order to avoid big swings in the policy rate (that could have an undesired effect on private expectations) or a zero bound (i.e. liquidity trap scenarios).

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