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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)

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    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.

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    File URL: http://www.economicdynamics.org/meetpapers/2009/paper_1118.pdf
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    Bibliographic Info

    Paper provided by Society for Economic Dynamics in its series 2009 Meeting Papers with number 1118.

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    Date of creation: 2009
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    Handle: RePEc:red:sed009:1118

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    Postal: Society for Economic Dynamics Christian Zimmermann Economic Research Federal Reserve Bank of St. Louis PO Box 442 St. Louis MO 63166-0442 USA
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    1. Nicola Cetorelli & Philip E. Strahan, 2004. "Finance as a Barrier to Entry: Bank Competition and Industry Structure in Local U.S. Markets," NBER Working Papers 10832, National Bureau of Economic Research, Inc.
    2. Hans Degryse & Steven Ongena, 2002. "Distance, Lending Relationships, and Competition," CSEF Working Papers 80, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy.
    3. Marc J. Melitz & Gianmarco I.P. Ottaviano, 2005. "Market Size, Trade, and Productivity," NBER Working Papers 11393, National Bureau of Economic Research, Inc.
    4. Jonathan Vogel, 2008. "Spatial Competition with Heterogeneous Firms," Journal of Political Economy, University of Chicago Press, vol. 116(3), pages 423-466, 06.
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    Cited by:
    1. JaeBin Ahn, 2011. "A Theory of Domestic and International Trade Finance," IMF Working Papers 11/262, International Monetary Fund.

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