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The role of bank capital in the propagation of shocks

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  • Meh, Césaire A.
  • Moran, Kevin

Abstract

The recent financial turmoil has underlined the importance of analyzing the link between banks' balance sheets and economic activity. We develop a dynamic stochastic general equilibrium model in which bank capital mitigates an agency problem between banks and their creditors. As a result, the capital position of banks affects their ability to attract loanable funds and therefore influences the business cycle through a bank capital channel of transmission. We find that the bank capital channel greatly amplifies and propagates the effects of technology shocks on output, investment and inflation. Moreover, bank capital shocks create sizeable declines in output and investment.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Economic Dynamics and Control.

Volume (Year): 34 (2010)
Issue (Month): 3 (March)
Pages: 555-576

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Handle: RePEc:eee:dyncon:v:34:y:2010:i:3:p:555-576

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Web page: http://www.elsevier.com/locate/jedc

Related research

Keywords: Bank capital Capital adequacy ratio Financial frictions Transmission mechanism of monetary policy;

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