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The Financial and Macroeconomic Implications of Banking Frictions and Banking Riskiness

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  • Yi Jin
  • Zhixiong Zeng

Abstract

This paper develops a model of banking frictions and banking riskiness, the importance of which is highlighted by the recent Global Financial Crisis (GFC). We propose a model-based approach to decompose the effect of a banking riskiness shock into a pure default effect and a risk effect when risk sharing among the depositors is imperfect. Although the default effect is quantitatively more important, the risk effect is not to be neglected. When the shock generates a bank spread similar in value to the peak during the GFC, the overall effect is a decline in employment by 6:57 percent. The pure default effect leads to a 4:76 percent employment decline by a “within-model” measure, and a 5:05 decline by a “between-model” measure. The remaining is attributed to the risk effect.

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File URL: http://www.buseco.monash.edu.au/eco/research/papers/2011/1411financialandmacrojinzen.pdf
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Bibliographic Info

Paper provided by Monash University, Department of Economics in its series Monash Economics Working Papers with number 14-11.

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Length: 40 pages
Date of creation: Jun 2011
Date of revision:
Handle: RePEc:mos:moswps:2011-14

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Keywords: Banking riskiness shocks; two-sided debt contract; default effects; risk effects; financial crisis.;

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  1. Stephen D. Williamson, 1989. "Restrictions on Financial Intermediaries and Implications for Aggregate Fluctuations: Canada and the United States 1870-1913," NBER Chapters, in: NBER Macroeconomics Annual 1989, Volume 4, pages 303-350 National Bureau of Economic Research, Inc.
  2. Cerasi, Vittoria & Daltung, Sonja, 2000. "The optimal size of a bank: Costs and benefits of diversification," European Economic Review, Elsevier, vol. 44(9), pages 1701-1726, October.
  3. Stiglitz, Joseph E & Weiss, Andrew, 1981. "Credit Rationing in Markets with Imperfect Information," American Economic Review, American Economic Association, vol. 71(3), pages 393-410, June.
  4. Krasa, Stefan & Villamil, Anne P, 1992. "A Theory of Optimal Bank Size," Oxford Economic Papers, Oxford University Press, vol. 44(4), pages 725-49, October.
  5. Mookherjee, Dilip & Png, Ivan, 1989. "Optimal Auditing, Insurance, and Redistribution," The Quarterly Journal of Economics, MIT Press, vol. 104(2), pages 399-415, May.
  6. Hellwig, Martin, 1998. "Financial Intermediation with Risk Aversion," Sonderforschungsbereich 504 Publications 98-39, Sonderforschungsbereich 504, Universität Mannheim & Sonderforschungsbereich 504, University of Mannheim.
  7. Williamson, Stephen D, 1987. "Financial Intermediation, Business Failures, and Real Business Cycles," Journal of Political Economy, University of Chicago Press, vol. 95(6), pages 1196-1216, December.
  8. Stephen D. Williamson, 1984. "Costly Monitoring, Financial Intermediation, and Equilibrium Credit Rationing," Working Papers 583, Queen's University, Department of Economics.
  9. Stefan Krasa & Anne P. Villamil, 2000. "Optimal Contracts when Enforcement Is a Decision Variable," Econometrica, Econometric Society, vol. 68(1), pages 119-134, January.
  10. Zeng, Zhixiong, 2010. "A theory of the non-neutrality of money with banking frictions and bank recapitalization," MPRA Paper 24752, University Library of Munich, Germany.
  11. Zhixiong Zeng, 2007. "The price of size and financial market allocations," Economic Theory, Springer, vol. 30(1), pages 21-48, January.
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