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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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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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Related research

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

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  1. Ben S. Bernanke & Mark Gertler, 1995. "Inside the Black Box: The Credit Channel of Monetary Policy Transmission," Journal of Economic Perspectives, American Economic Association, American Economic Association, vol. 9(4), pages 27-48, Fall.
  2. Ibrahim Chowdhury & Mathias Hoffmann & Andreas Schabert, . "Inflation Dynamics and the Cost Channel of Monetary Transmission," Working Papers, Business School - Economics, University of Glasgow 2003_19, Business School - Economics, University of Glasgow, revised Oct 2003.
  3. Thomas Helbling & M. Ayhan Kose & Christopher Otrok & Raju Huidrom, 2010. "Do Credit Shocks Matter? A Global Perspective," IMF Working Papers, International Monetary Fund 10/261, International Monetary Fund.
  4. Chen, Nan-Kuang, 2001. "Bank net worth, asset prices and economic activity," Journal of Monetary Economics, Elsevier, Elsevier, vol. 48(2), pages 415-436, October.
  5. Ravenna, Federico & Walsh, Carl E., 2006. "Optimal monetary policy with the cost channel," Journal of Monetary Economics, Elsevier, Elsevier, vol. 53(2), pages 199-216, March.
  6. Andrea Gerali & Stefano Neri & Luca Sessa & Federico M. Signoretti, 2010. "Credit and Banking in a DSGE Model of the Euro Area," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 42(s1), pages 107-141, 09.
  7. Dedola, Luca & Neri, Stefano, 2006. "What does a technology shock do? A VAR analysis with model-based sign restrictions," Working Paper Series, European Central Bank 0705, European Central Bank.
  8. Wollmershäuser, Timo & Mayer, Eric & Hülsewig, Oliver, 2006. "Bank Behavior and the Cost Channel of Monetary Transmission," W.E.P. - Würzburg Economic Papers, University of Würzburg, Chair for Monetary Policy and International Economics 71, University of Würzburg, Chair for Monetary Policy and International Economics.
  9. Binder,M. & Pesaran,H.M., 1995. "Multivariate Rational Expectations Models and Macroeconomic Modelling: A Review and Some New Results," Cambridge Working Papers in Economics, Faculty of Economics, University of Cambridge 9415, Faculty of Economics, University of Cambridge.
  10. Adrian, Tobias & Song Shin, Hyun, 2010. "Financial Intermediaries and Monetary Economics," Handbook of Monetary Economics, Elsevier, in: Benjamin M. Friedman & Michael Woodford (ed.), Handbook of Monetary Economics, edition 1, volume 3, chapter 12, pages 601-650 Elsevier.
  11. Canova, Fabio & López-Salido, J David & Michelacci, Claudio, 2008. "The Effects of Technology Shocks on Hours and Output: A Robustness Analysis," CEPR Discussion Papers, C.E.P.R. Discussion Papers 6720, C.E.P.R. Discussion Papers.
  12. Binder, Michael & Pesaran, M. Hashem, 1997. "Multivariate Linear Rational Expectations Models," Econometric Theory, Cambridge University Press, Cambridge University Press, vol. 13(06), pages 877-888, December.
  13. Gertler, Mark & Karadi, Peter, 2011. "A model of unconventional monetary policy," Journal of Monetary Economics, Elsevier, Elsevier, vol. 58(1), pages 17-34, January.
  14. Koop, Gary & Pesaran, M. Hashem & Potter, Simon M., 1996. "Impulse response analysis in nonlinear multivariate models," Journal of Econometrics, Elsevier, Elsevier, vol. 74(1), pages 119-147, September.
  15. Christiano, Lawrence & Ilut, Cosmin & Motto, Roberto & Rostagno, Massimo, 2008. "Monetary policy and stock market boom-bust cycles," Working Paper Series, European Central Bank 0955, European Central Bank.
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  17. Alexius, Annika & Carlsson, Mikael, 2007. "Production function residuals, VAR technology shocks, and hours worked: Evidence from industry data," Economics Letters, Elsevier, Elsevier, vol. 96(2), pages 259-263, August.
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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. Sergei Ivashchenko, 2013. "Dynamic stochastic general equilibrium model with banks and endogenous defaults of firms," EUSP Deparment of Economics Working Paper Series, European University at St. Petersburg, Department of Economics Ec-02/13, European University at St. Petersburg, Department of Economics.

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