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Banks, Credit Market Frictions, and Business Cycles

  • Ali Dib
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The author proposes a micro-founded framework that incorporates an active banking sector into a dynamic stochastic general-equilibrium model with a financial accelerator. He evaluates the role of the banking sector in the transmission and propagation of the real effects of aggregate shocks, and assesses the importance of financial shocks in U.S. business cycle fluctuations. The banking sector consists of two types of profitmaximizing banks that offer different banking services and transact in an interbank market. Loans are produced using interbank borrowing and bank capital subject to a regulatory capital requirement. Banks have monopoly power, set nominal deposit and prime lending rates, choose their leverage ratio and their portfolio composition, and can endogenously default on a fraction of their interbank borrowing. Because it is costly to raise capital to satisfy the regulatory capital requirement, the banking sector attenuates the real effects of financial shocks, reduces macroeconomic volatilities, and helps stabilize the economy. The model also includes two unconventional monetary policies (quantitative and qualitative easing) that reduce the negative impacts of financial crises.

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File URL: http://www.bankofcanada.ca/wp-content/uploads/2010/10/wp10-24.pdf
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Paper provided by Bank of Canada in its series Working Papers with number 10-24.

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Length: 48 pages
Date of creation: 2010
Date of revision:
Handle: RePEc:bca:bocawp:10-24
Contact details of provider: Postal: 234 Wellington Street, Ottawa, Ontario, K1A 0G9, Canada
Phone: 613 782-8845
Fax: 613 782-8874
Web page: http://www.bank-banque-canada.ca/

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  1. Skander Van den Heuvel, 2005. "The Welfare Cost of Bank Capital Requirements," 2005 Meeting Papers 880, Society for Economic Dynamics.
  2. F. Degraeve, 2007. "The External Finance Premium and the Macroeconomy: US post-WWII Evidence," Working Papers of Faculty of Economics and Business Administration, Ghent University, Belgium 07/482, Ghent University, Faculty of Economics and Business Administration.
  3. Skander Van den Heuvel, 2006. "The Bank Capital Channel of Monetary Policy," 2006 Meeting Papers 512, Society for Economic Dynamics.
  4. Virginia Queijo von Heideken, 2009. "How Important are Financial Frictions in the United States and the Euro Area?," Scandinavian Journal of Economics, Wiley Blackwell, vol. 111(3), pages 567-596, 09.
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