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Banks, Credit Market Frictions, and Business Cycles

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  • Ali Dib
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Abstract

The author proposes a micro-founded framework that incorporates an active banking sector into a dynamic stochastic general-equilibrium model with a financial accelerator. He evaluates the role of the banking sector in the transmission and propagation of the real effects of aggregate shocks, and assesses the importance of financial shocks in U.S. business cycle fluctuations. The banking sector consists of two types of profitmaximizing banks that offer different banking services and transact in an interbank market. Loans are produced using interbank borrowing and bank capital subject to a regulatory capital requirement. Banks have monopoly power, set nominal deposit and prime lending rates, choose their leverage ratio and their portfolio composition, and can endogenously default on a fraction of their interbank borrowing. Because it is costly to raise capital to satisfy the regulatory capital requirement, the banking sector attenuates the real effects of financial shocks, reduces macroeconomic volatilities, and helps stabilize the economy. The model also includes two unconventional monetary policies (quantitative and qualitative easing) that reduce the negative impacts of financial crises.

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Bibliographic Info

Paper provided by Bank of Canada in its series Working Papers with number 10-24.

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Length: 48 pages
Date of creation: 2010
Date of revision:
Handle: RePEc:bca:bocawp:10-24

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Related research

Keywords: Economic models; Business fluctuations and cycles; Credit and credit aggregates; Financial stability;

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References

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  1. Skander Van den Heuvel, 2006. "The Bank Capital Channel of Monetary Policy," 2006 Meeting Papers 512, Society for Economic Dynamics.
  2. Virginia Queijo von Heideken, 2009. "How Important are Financial Frictions in the United States and the Euro Area?," Scandinavian Journal of Economics, Wiley Blackwell, vol. 111(3), pages 567-596, 09.
  3. F. Degraeve, 2007. "The External Finance Premium and the Macroeconomy: US post-WWII Evidence," Working Papers of Faculty of Economics and Business Administration, Ghent University, Belgium 07/482, Ghent University, Faculty of Economics and Business Administration.
  4. Skander Van den Heuvel, 2005. "The Welfare Cost of Bank Capital Requirements," 2005 Meeting Papers 880, Society for Economic Dynamics.
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Citations

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Cited by:
  1. Ali Dib, 2010. "Capital Requirement and Financial Frictions in Banking: Macroeconomic Implications," Working Papers 10-26, Bank of Canada.
  2. Gerke, R. & Jonsson, M. & Kliem, M. & Kolasa, M. & Lafourcade, P. & Locarno, A. & Makarski, K. & McAdam, P., 2013. "Assessing macro-financial linkages: A model comparison exercise," Economic Modelling, Elsevier, vol. 31(C), pages 253-264.
  3. Tatom, John A., 2014. "U.S. monetary policy in disarray," Journal of Financial Stability, Elsevier, vol. 12(C), pages 47-58.
  4. Scott Davis, 2011. "Financial integration and international business cycle co-movement: the role of balance sheets," Globalization and Monetary Policy Institute Working Paper 89, Federal Reserve Bank of Dallas.
  5. M. Falagiarda & A. Saia, 2013. "Credit, Endogenous Collateral and Risky Assets: A DSGE Model," Working Papers wp916, Dipartimento Scienze Economiche, Universita' di Bologna.
  6. Robert Kollmann & Stefan Zeugner, 2011. "Leverage as a Predictor for Real Activity and Volatility," Working Papers ECARES ECARES 2011-009, ULB -- Universite Libre de Bruxelles.
  7. Scott Davis & Kevin X.D. Huang, 2011. "Optimal monetary policy under financial sector risk," Globalization and Monetary Policy Institute Working Paper 85, Federal Reserve Bank of Dallas.
  8. Samano, Daniel, 2011. "In the quest of macroprudential policy tools," MPRA Paper 30738, University Library of Munich, Germany.
  9. Hwang, Yu-Ning, 2012. "Financial friction in an emerging economy," Journal of International Money and Finance, Elsevier, vol. 31(2), pages 212-227.

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