Financial System Regulatory Policy and Macroeconomic Performance: a General Equilibrium Analysis

In a variety of economies, recent years have witnessed prominent alterations in the regulatory framework under which financial systems operate. Most notable among these alterations are the host of revisions to the regulatory framework faced by financial intermediaries such as banks. From a theoretical perspective, this paper assesses the potential impact of regulatory policy on macroeconomic aggregates and the behavior of financial intermediaries. The general equilibrium model employed in this paper extends the neoclassical real business cycle framework by incorporating a financial intermediary with access to a stochastic capital-generating technology. In the presence of a deposit insurance system, intermediaries may choose to screen this technology and have direct control over the volatility of the capital return. I find that in the model’s steady-state, the deposit insurance premium exerts leverage over equilibrium screening and economy-wide consumption but has an ambiguous effect on the volatility of the intermediary’s portfolio. ∗Department of Economics, United States Naval Academy, 589 McNair Rd., Annapolis, MD, 21402-5030, U. S. A. Email: [email protected]. This paper was presented as part of the ”Financial Markets, Business Cycles, and Growth Conference”, Birkbeck College, University of London, March 14-15 2003.