Explaining Bank Credit Crunches and Procyclicality

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Explaining Bank Credit Crunches and Procyclicality

In "Explaining Bank Credit Crunches and Procyclicality," Robert R. Bliss and George G. Kaufman modifiy the simple deposit expansion model by adding a capital constraint to the required reserve constraint limiting bank creation of deposits and acquisition of earning assets. Binding capital requirements weaken a central bank’s ability to implement expansionary monetary policy and explain the occurrence of credit crunches and procyclicality.

Why do money supply expansion models treat excess reserves as suboptimal? What actions can banks take to lower their excess reserves? How do these actions affect the money supply?
What are capital requirements? From what sources do they arise?
How does the inclusion of capital requirements alter the story of what happens when the Fed conducts open market purchases to inject additional reserves into the banking system?
Why are capital requirements most likely to be binding during a recession? What implications does this have for credit crunches, procyclicality, and the earning assets banks choose?

Source: “Explaining Bank Credit Crunches and Procyclicality.” Robert R. Bliss and George G. Kaufman, Federal Reserve Bank of Chicago Fed Letter, No. 179, July 2002, pp. 1-4.

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