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The Instability of the Banking Sector and Macrodynamics: Theory and Empirics

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  • Stefan Mittnik
  • Willi Semmler

Abstract

This paper studies the issue of local instability of the banking sector and how it may spillover to the macroeconomy. The banking sector is considered here as representing a wealth fund that accumulates capital assets, can heavily borrow and pays bonuses. We presume that the banking system faces not only loan losses but is also exposed to a deterioration of its balances sheets due to adverse movements in asset prices. In contrast to previous studies that use the financial accelerator – which is locally amplifying but globally stable and mean reverting – our model shows local instability and globally multiple regimes. Whereas the financial accelerator leads, in terms of econometrics, to a one-regime VAR we demonstrate the usefulness of a multi-regime VAR (MRVAR). We estimate our model for the US with a MRVAR using a constructed financial stress index and industrial production. We also undertake an impulse-response study with an MRVAR which allows us to explore regime dependent shocks. We show that the shocks have asymmetric effects depending on the regime the economy is in and the size of the shocks. As to the recently discussed unconventional monetary policy of quantitative easing we demonstrate that the effects of monetary shocks are also dependent on the size of the shocks.

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Bibliographic Info

Paper provided by DEGIT, Dynamics, Economic Growth, and International Trade in its series DEGIT Conference Papers with number c016_080.

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Length: 54 pages
Date of creation: Sep 2011
Date of revision:
Handle: RePEc:deg:conpap:c016_080

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  1. Yuliy Sannikov & Markus Brunnermeier, 2012. "A Macroeconomic Model with a Financial Sector," 2012 Meeting Papers 507, Society for Economic Dynamics.
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  17. Grune, Lars & Semmler, Willi, 2004. "Using dynamic programming with adaptive grid scheme for optimal control problems in economics," Journal of Economic Dynamics and Control, Elsevier, vol. 28(12), pages 2427-2456, December.
  18. Illing, Mark & Liu, Ying, 2006. "Measuring financial stress in a developed country: An application to Canada," Journal of Financial Stability, Elsevier, vol. 2(3), pages 243-265, October.
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Cited by:
  1. Shrestha, Prakash Kumar, 2013. "Banking Ssystems, central banks and international reserve accumulation in East Asian economies," Economics - The Open-Access, Open-Assessment E-Journal, Kiel Institute for the World Economy, vol. 7(14), pages 1-29.
  2. Shrestha, Prakash Kumar, 2012. "Banking systems, central banks and international reserve accumulation in East Asian economies," Economics Discussion Papers 2012-48, Kiel Institute for the World Economy.

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