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Bank Capital, Agency Costs, and Monetary Policy

  • Césaire Meh
  • Kevin Moran

Evidence suggests that banks, like firms, face financial frictions when raising funds. The authors develop a quantitative, monetary business cycle model in which agency problems affect both the relationship between banks and firms and the relationship between banks and their depositors. As a result, bank capital and entrepreneurial net worth jointly determine aggregate investment, and are important determinants of the propagation of shocks. The authors find that the effects of monetary policy and technology shocks are dampened but more persistent in their model than in an economy where the information friction that banks face is reduced or eliminated. After documenting that the bank capital-asset ratio is countercyclical in the data, the authors show that their model, in which movements in this ratio are market-determined, can replicate the countercyclical ratio.

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File URL: http://www.bankofcanada.ca/wp-content/uploads/2010/02/wp04-6.pdf
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Paper provided by Bank of Canada in its series Working Papers with number 04-6.

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Length: 55 pages
Date of creation: 2004
Date of revision:
Handle: RePEc:bca:bocawp:04-6
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Web page: http://www.bank-banque-canada.ca/

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  1. Charles T. Carlstrom & Timothy S. Fuerst, 1996. "Agency costs, net worth, and business fluctuations: a computable general equilibrium analysis," Working Paper 9602, Federal Reserve Bank of Cleveland.
  2. Berger, Allen N, 2003. " The Economic Effects of Technological Progress: Evidence from the Banking Industry," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 35(2), pages 141-76, April.
  3. Bernanke, B. & Gertler, M. & Gilchrist, S., 1998. "The Financial Accelerator in a Quantitative Business Cycle Framework," Working Papers 98-03, C.V. Starr Center for Applied Economics, New York University.
  4. Patrick Bolton & Xavier Freixas, 2000. "Corporate finance and the monetary transmission mechanism," Economics Working Papers 511, Department of Economics and Business, Universitat Pompeu Fabra.
  5. Andolfatto, David, 1996. "Business Cycles and Labor-Market Search," American Economic Review, American Economic Association, vol. 86(1), pages 112-32, March.
  6. Ben S. Bernanke & Mark L. Gertler, 1985. "Banking in General Equilibrium," NBER Working Papers 1647, National Bureau of Economic Research, Inc.
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