The macroeconomic events in the latter half of 2008 have sparked renewed interest in the role of financial shocks in the business cycle and the appropriate response of monetary policy to these shocks.
This paper adds to this discussion by formally integrating a model of agency costs into an otherwise standard Dynamic New Keynesian (DNK) model. We do so in such a way that the agency-cost mechanism is quite transparent so that interactions between sticky prices and agency cost distortions are clearly identified. In addition our framework enables us to derive analytical expressions for the model-consistent welfare function.
ADRs bring the advantages of liquidity, transparency, and ease of trade of the US markets to emerging markets. As investors (both foreign and local) choose ADRs, local exchanges, brokers, and regulatory authorities come under pressure to modernize operations, enhance disclosure standards, and strengthen enforcement in order to make the local market more liquid, transparent, and efficient.
Through these activities, the local market becomes more developed. We would then expect that, in addition to increased participation by local companies and investors, the more sophisticated US investors would increasingly buy and sell in the home markets of foreign shares rather than through ADRs. Thus, many foreign companies would use the US markets as a temporary mechanism to access US funds and gain international investor credibility and visibility. The development of the ADR market would then result in the further development of the local market, as more local investors and companies enter this more efficient market.
There has been a strong interest in understanding interactions between bank capital regulation and macroeconomic fluctuations among policy makers and academic researchers. The interest has become even stronger in the aftermath of the recent financial crisis. One of the key concerns, especially from a macroeconomic perspective, is that bank capital regulation can induce significant “procyclicality,” meaning that bank capital regulation can amplify the macroeconomic fluctuations. The procyclical effect was recognized under the first bank capital regulation, i.e., Basel I, in which banks are required to hold a constant fraction of equity. The procyclicality issue has received significantly more attention under the so-called risk-sensitive regulation (Basel II). Under Basel II, the risk weight associated with each loan is negatively related to the borrower’s credit quality; therefore, during an economic down-turn when overall credit quality deteriorates, capital requirements become more stringent. This further limits banks’ lending capacity. Our interest is to quantify the procyclical effects using a general equilibrium macroeconomic model.
There are many papers with similar interests. Blum and Hellwig (1995) examine the procyclical effects of fixed capital requirements under Basel I. Using a simple reduced-form macroeconomic framework, they argue that it is likely to amplify macroeconomic fluctuations. Heid (2007) goes one step further by studying the implications of risk-sensitive capital requirements in a similar reduced-form environment. More recently, Zhu (2008) studies the effects of bank capital regulation on banks’ behavior by applying the industry model of Cooley and Quadrini (2001) to a banking sector that is subject to risk-sensitive capital requirements. Finally, Repullo and Suarez (2009) develop a micro-founded partial equilibrium model of relationship banking and analyze the banks’ behavior under risk-sensitive capital requirements. They show that the procyclicality under Basel II can be sizable.
