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Balance-Sheet Shocks and Recapitalizations

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  • Mr. Damiano Sandri
  • Mr. 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.

Suggested Citation

  • Mr. Damiano Sandri & Mr. Fabian Valencia, 2012. "Balance-Sheet Shocks and Recapitalizations," IMF Working Papers 2012/068, International Monetary Fund.
    • Handle: RePEc:imf:imfwpa:2012/068
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    References listed on IDEAS

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    Cited by:

    1. 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.
    2. Kollmann, Robert & Ratto, Marco & Roeger, Werner & in′t Veld, Jan, 2013. "Fiscal policy, banks and the financial crisis," Journal of Economic Dynamics and Control, Elsevier, vol. 37(2), pages 387-403.
    3. Valencia, Fabián, 2014. "Banks' Precautionary Capital And Credit Crunches," Macroeconomic Dynamics, Cambridge University Press, vol. 18(8), pages 1726-1750, December.

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