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Unexpected loan losses and bank capital in an estimated DSGE model of the euro area

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  • Hristov, Nikolay
  • Hülsewig, Oliver

Abstract

We present a stylized DSGE model in which banks face unexpected losses in their loan portfolios and are subject to capital regulation. The framework is used to explore the importance of the interaction between macroeconomic conditions, credit default and bank capitalization for the transmission of macroeconomic shocks. We fit the model to euro area data. Impulse response analysis shows that the aforementioned interaction substantially magnifies the responsiveness of the economy to demand side and monetary disturbances. The amplification is especially strong with respect to government spending shocks. The model is further capable of replicating two financial market characteristics that are documented in the empirical literature, i.e. the pro-cyclicality of bank profitability and the counter-cyclical response of firm default rates and credit spreads to monetary policy shocks.

Suggested Citation

  • Hristov, Nikolay & Hülsewig, Oliver, 2017. "Unexpected loan losses and bank capital in an estimated DSGE model of the euro area," Journal of Macroeconomics, Elsevier, vol. 54(PB), pages 161-186.
  • Handle: RePEc:eee:jmacro:v:54:y:2017:i:pb:p:161-186
    DOI: 10.1016/j.jmacro.2017.02.001
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    Keywords

    DSGE model; Bank capital; Aggregate loan losses; Business cycle fluctuations;

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E51 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Money Supply; Credit; Money Multipliers
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

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