The Macroeconomic Effects of Basel III Regulations With Endogenous Credit and Money Creation

When banks create credit and money endogenously, how do Basel III regulations affect the macroeconomy? This study develops a simple monetary circuit model based on the stock-flow consistent framework. It analytically solves for the equilibrium where banks comply with the capital adequacy ratio or net stable funding ratio. The growth rates can decompose into the money creation processes. The primary component is lending, which depends on bank spreads (or profitability) and regulatory rules. Moreover, this study reveals a channel through which credit and money creation affect economic growth. Debt ratios of firms are related to their animal spirits and the economy’s growth rates, and this relationship implies conditions for firms using debt and going bankrupt. Finally, results reveal that regulations can transfer risk from banks to firms. These findings shed new light on banks’ macroeconomic roles and the effects of bank regulations