DP309 The Macroeconomic Implications of Financial Deregulation

Author(s): Christian Bordes, Jacques Melitz
Publication Date: June 1989
Keyword(s): Bank Failure, Banking, Monetary Policy, Regulation
JEL(s): 311, 312
Programme Areas: International Macroeconomics, Applied Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=309

This paper explores the possible macroeconomic consequences of financial deregulation in an institutional environment where deregulation raises risks in banking. The central bank is assumed to maximize an objective function an argument of which is the probability of bank failure. It is then shown that the usual trade-offs between policy objectives imply that financial deregulation will affect optimal monetary policy: deregulation will lead to more interest rate smoothing than would otherwise be the case. Because of restricted entry into banking, deregulation will also call for some inflation. The framework for the discussion is a Poole model with a Lucas supply function and imperfect wage indexation.