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The countercyclical capital buffer: A DSGE approach

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We address the stabilization performance of the Countercyclical Capital Buffer (CCyB) under distinct sources of expectation-driven business cycle fluctuations. Our environment is a Dynamic Stochastic General Equilibrium (DSGE) model for a small euro area economy. The model is endowed with a banking system where capital requirements and credit restrictions may trigger credit tightness and/or interest rate spread hikes. For fluctuation sources impacting a largely procyclical credit demand, the CCyB rule based on the credit-to-GDP gap is endowed with the proper stabilization timing and has important stabilization effects by alleviating the cost of credit of a fragile entrepreneurial sector. This is achieved at the expense of private consumption, depressed by the wealth reduction associated with the buffer build up. Under cycles affecting credit supply, the CCyB still plays a stabilization role but with milder effects as the entrepreneurial sector is more resilient and able to cope with interest rate spread hikes imposed by the banking sector. For fluctuation sources where credit is countercyclical the CCyB may have a destabilizing role, since the buffer is not released in the proper timing.
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