Liquidity Management of Heterogeneous Banks during the Great Recession

I construct a dynamic stochastic general equilibrium model to investigate how the liquidity management of different size banks responds to liquidity and loan demand shocks. My investigation shows the following. Compared with small banks, large banks tend to be net borrowers and thus more exposed to liquidity risk. In response to negative liquidity shocks, large banks decrease their credit supply while small ones increase theirs. In response to negative loan demand shocks, both large and small banks decrease their credit supply. Connecting these implications with the panel data, I argue that negative liquidity shocks served as the main driver of the Great Recession initially, and negative demand shocks did so later, and that demand shocks accounted for two thirds of the greatest fall in aggregate loans during the recession.