A Dilemma between Liquidity Regulation and Monetary Policy: Some History and Theory
2020
History suggests a conflict between current Basel III liquidity ratios and monetary policy,
which we call the liquidity regulation dilemma. Although forgotten, liquidity ratios, named
"securities-reserve requirements", were widely used historically, but for monetary policy (not
regulatory) reasons, as central bankers recognized the contractionary effects of these ratios.
We build a model rationalizing historical policies: a tighter ratio reduces the quantity of assets
that banks can pledge as collateral, thus increasing interest rates. Tighter liquidity regulation
paradoxically increases the need for central bank's interventions. Liquidity ratios were also
used to keep yields on government bonds low when monetary policy tightened
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