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Balance-Sheet Shocks and Recapitalizations

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Author Info

  • Damiano Sandri
  • Fabian Valencia

Abstract

We develop a dynamic stochastic general equilibrium model with financial frictions on both financial intermediaries and goods-producing firms. In this context, due to high leverage of financial intermediaries, balance sheet disruptions in the financial sector are particularly detrimental for aggregate output. We show that the welfare gains from recapitalizing the financial sector in response to large but rare net worth losses are as large as those from eliminating business cycle fluctuations. We also find that these gains are increasing in the size of the net worth loss, are larger when recapitalization funds are raised from the household rather than the real sector, and may increase with a reduction in financial intermediaries idiosyncratic risk.

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Bibliographic Info

Paper provided by International Monetary Fund in its series IMF Working Papers with number 12/68.

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Length: 26
Date of creation: 01 Mar 2012
Date of revision:
Handle: RePEc:imf:imfwpa:12/68

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Related research

Keywords: Bankruptcy; Economic models; External shocks; Financial sector; Intervention; financial intermediaries; deposit rate; financial intermediation; moral hazard; competitive markets; financial institutions; marginal product; bonds; financial innovation; financial markets; liquidity support;

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References

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  1. Naohisa Hirakata & Nao Sudo & Kozo Ueda, 2013. "Capital Injection, Monetary Policy, and Financial Accelerators," International Journal of Central Banking, International Journal of Central Banking, vol. 9(2), pages 101-145, June.
  2. Vasco Cúrdia & Michael Woodford, 2009. "Credit frictions and optimal monetary policy," BIS Working Papers 278, Bank for International Settlements.
  3. Chen, Nan-Kuang, 2001. "Bank net worth, asset prices and economic activity," Journal of Monetary Economics, Elsevier, vol. 48(2), pages 415-436, October.
  4. Robert Kollmann & Werner Roeger & Jan in't Veld, 2012. "Fiscal Policy in a Financial Crisis: Standard Policy versus Bank Rescue Measures," American Economic Review, American Economic Association, vol. 102(3), pages 77-81, May.
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Cited by:
  1. Robert Kollmann & Marco Ratto & Werner Roeger & Jan in'tVeld, 2012. "Fiscal Policy, Banks and the Financial Crisis," Working Papers ECARES ECARES 2012-034, ULB -- Universite Libre de Bruxelles.
  2. Robert Kollmann & Werner Roeger & Jan in'tVeld, 2012. "Fiscal Policy in a Financial Crisis: Standard Policy vs. Bank Rescue Measure," Working Papers ECARES ECARES 2012-008, ULB -- Universite Libre de Bruxelles.

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