Essays on Financial Regulation in Macroeconomics
Bengui, Julien Yonathan
Mendoza, Enrique G
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This dissertation investigates two aspects of how to regulate the financial sector optimally in order to increase macroeconomic stability and mitigate the risk of future financial crises. Chapter 1 analyzes the desirability of international coordination in financial regulation. It develops a two-country model of systemic liquidity risk-taking in which financial market imperfections provide a rationale for macro-prudential regulation. In the model, curbing liquidity risk-taking via regulation lowers the price of liquidity during financial crises and thereby reduces the costs associated with market incompleteness. But regulation also entails costs in the form of distortions to productive investment decisions. The discrepancy between the domestic dimension of the costs and the global dimension of the benefits of regulation generates free-riding incentives among regulators operating in different countries. The theory predicts that absent international coordination, national authorities are tempted to regulate their financial systems in a way that results in excessive illiquidity. It therefore speaks in favor of a stronger global coordination of banking regulation. Chapter 2 analyzes the social optimality of private debt maturity choices. It studies debt maturity decisions in a dynamic macroeconomic model in which financial frictions give rise to systemic risk in the form of amplification effects. Long-term liabilities provide insurance against shocks to the asset side of the balance sheet, but they come at an extra cost. The debt maturity structure therefore maps into an allocation of macroeconomic risk between lenders and leveraged borrowers, and fundamental shocks propagate more powerfully in the economy when the maturity is shorter. The market equilibrium is not constrained efficient as borrowers fail to internalize their contribution to systemic risk and take on too much short-term debt in a decentralized economy. The theory indicates that a tax on short-term debt -- a form of macroprudential policy -- leads to Pareto improvements and results in less volatile allocations and asset prices.