Interaction Between Monetary Policy and Regulatory Capital Requirements

Banks’ behaviour can be influenced by both monetary policy and regulatory capital requirements. This paper explores the interaction between these two policy tools in promoting better lending decisions by banks. We develop and calibrate a model of bank lending to examine what an optimal combination of monetary policy and regulatory capital requirements might look like. We find that as prudential standards strengthen globally in the aftermath of the financial crises, it is likely that the that equilibrium level of central bank policy rates should be lower than they had been prior to the crisis.