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Bank Competition and Economic Stability: The Role of Monetary Policy

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  • Sylvain Champonnois

    (Rady School of Management, University of California, San Diego)

Abstract

This paper analyzes the dual role of monetary policy for economic efficiency and stability in a model of endogenous bank competition. Multiple equilibria emerge from the complementarity between bank and non-financial firm decisions. Adverse aggregate or idiosyncratic liquidity shocks may cause a breakdown in which the economy collapses into a no-production equilibrium. Less bank competition improves the profitability of banks and makes the economy less vulnerable to adverse shocks but it also distorts the efficient allocation of capital. This stability/efficiency tradeoff creates a motive for monetary policy to be tight when liquidity is abundant to spur bank competition and to be loose in bad times to restore the profitability of banks and decrease the likelihood of economic and financial crashes.

Suggested Citation

  • Sylvain Champonnois, 2009. "Bank Competition and Economic Stability: The Role of Monetary Policy," 2009 Meeting Papers 1118, Society for Economic Dynamics.
    • Handle: RePEc:red:sed009:1118
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    References listed on IDEAS

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    Cited by:

    1. Sylvain Champonnois, 2011. "The limits of market discipline: proprietary trading and aggregate risk," 2011 Meeting Papers 1013, Society for Economic Dynamics.
    2. Mr. JaeBin Ahn, 2011. "A Theory of Domestic and International Trade Finance," IMF Working Papers 2011/262, International Monetary Fund.

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