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Business Cycle Effects of Credit and Technology Shocks in a DSGE Model with Firm Defaults

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  • M. Hashem Pesaran
  • TengTeng Xu

Abstract

This paper proposes a theoretical framework to analyze the impacts of credit and technology shocks on business cycle dynamics, where firms rely on banks and households for capital financing. Firms are identical ex ante but differ ex post due to different realizations of firm specific technology shocks, possibly leading to default by some firms. The paper advances a new modelling approach for the analysis of financial intermediation and firm defaults that takes account of the financial implications of such defaults for both households and banks. Results from a calibrated version of the model highlights the role of financial institutions in the transmission of credit and technology shocks to the real economy. A positive credit shock, defined as a rise in the loan to deposit ratio, increases output, consumption, hours and productivity, and reduces the spread between loan and deposit rates. The effects of the credit shock tend to be highly persistent even without price rigidities and habit persistence in consumption behaviour.

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File URL: http://www.cesifo-group.de/portal/page/portal/DocBase_Content/WP/WP-CESifo_Working_Papers/wp-cesifo-2011/wp-cesifo-2011-10/cesifo1_wp3609.pdf
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Bibliographic Info

Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 3609.

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Date of creation: 2011
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Handle: RePEc:ces:ceswps:_3609

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Keywords: bank credit; financial intermediation; firm heterogeneity and defaults; interest rate spread; real financial linkages;

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References

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  1. Dedola, Luca & Neri, Stefano, 2007. "What does a technology shock do? A VAR analysis with model-based sign restrictions," Journal of Monetary Economics, Elsevier, vol. 54(2), pages 512-549, March.
  2. Wollmershäuser, Timo & Mayer, Eric & Hülsewig, Oliver, 2006. "Bank Behavior and the Cost Channel of Monetary Transmission," W.E.P. - Würzburg Economic Papers 71, University of Würzburg, Chair for Monetary Policy and International Economics.
  3. Binder, Michael & Pesaran, M. Hashem, 1997. "Multivariate Linear Rational Expectations Models," Econometric Theory, Cambridge University Press, vol. 13(06), pages 877-888, December.
  4. Ibrahim Chowdhury & Mathias Hoffmann & Andreas Schabert, 2004. "Inflation Dynamics And The Cost Channel Of Monetary Transmission," Royal Economic Society Annual Conference 2004 80, Royal Economic Society.
  5. Christiano, Lawrence & Ilut, Cosmin & Motto, Roberto & Rostagno, Massimo, 2008. "Monetary policy and stock market boom-bust cycles," Working Paper Series 0955, European Central Bank.
  6. Thomas Helbling & M. Ayhan Kose & Christopher Otrok & Raju Huidrom, 2010. "Do Credit Shocks Matter? A Global Perspective," IMF Working Papers 10/261, International Monetary Fund.
  7. Chen, Nan-Kuang, 2001. "Bank net worth, asset prices and economic activity," Journal of Monetary Economics, Elsevier, vol. 48(2), pages 415-436, October.
  8. Binder,M. & Pesaran,H.M., 1995. "Multivariate Rational Expectations Models and Macroeconomic Modelling: A Review and Some New Results," Cambridge Working Papers in Economics 9415, Faculty of Economics, University of Cambridge.
  9. Bernanke, Ben & Gertler, Mark, 1995. "Inside the Black Box: The Credit Channel of Monetary Policy Transmission," Working Papers 95-15, C.V. Starr Center for Applied Economics, New York University.
  10. Ravenna, Federico & Walsh, Carl E., 2006. "Optimal monetary policy with the cost channel," Journal of Monetary Economics, Elsevier, vol. 53(2), pages 199-216, March.
  11. Fabio Canova & David Lopez-Salido & Claudio Michelacci, 2010. "The effects of technology shocks on hours and output: a robustness analysis," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 25(5), pages 755-773.
  12. Alexius, Annika & Carlsson, Mikael, 2007. "Production function residuals, VAR technology shocks, and hours worked: Evidence from industry data," Economics Letters, Elsevier, vol. 96(2), pages 259-263, August.
  13. Koop, Gary & Pesaran, M. Hashem & Potter, Simon M., 1996. "Impulse response analysis in nonlinear multivariate models," Journal of Econometrics, Elsevier, vol. 74(1), pages 119-147, September.
  14. Andrea Gerali & Stefano Neri & Luca Sessa & Federico M. Signoretti, 2010. "Credit and banking in a DSGE model of the euro area," Temi di discussione (Economic working papers) 740, Bank of Italy, Economic Research and International Relations Area.
  15. Greenwood, Jeremy & Hercowitz, Zvi & Huffman, Gregory W, 1988. "Investment, Capacity Utilization, and the Real Business Cycle," American Economic Review, American Economic Association, vol. 78(3), pages 402-17, June.
  16. Gertler, Mark & Karadi, Peter, 2011. "A model of unconventional monetary policy," Journal of Monetary Economics, Elsevier, vol. 58(1), pages 17-34, January.
  17. David Aikman & Matthias Paustian, 2006. "Bank capital, asset prices and monetary policy," Bank of England working papers 305, Bank of England.
  18. Césaire Meh & Kevin Moran, 2004. "Bank Capital, Agency Costs, and Monetary Policy," Working Papers 04-6, Bank of Canada.
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Cited by:
  1. Franziska Bremus, 2011. "Financial Integration and Macroeconomic Stability: What Role for Large Banks?," Discussion Papers of DIW Berlin 1178, DIW Berlin, German Institute for Economic Research.
  2. Ivashchenko, S., 2013. "Dynamic Stochastic General Equilibrium Model with Banks and Endogenous Defaults of Firms," Journal of the New Economic Association, New Economic Association, vol. 19(3), pages 27-50.

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