Macroprudential Policy with Liquidity Panics

Abstract We study the optimality of macroprudential policies in an environment where banks provide liquidity to firms. Informational frictions between can cause interbank market freezes, prompting firms accumulate their own liquid assets. Liquidity hoarding by turn reduces demand for bank loans and profitability, makes freezes even more likely, may ultimately trigger a self-fulfilling bad equilibrium. Such “liquidity panics” additional rationale requirements on banks, which alleviate banking sector and, paradoxically, increase aggregate investment. Instead, encouraging lending have opposite effect.