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Real-financial Linkages through Loan Default and Bank Capital

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  • Tamon Takamura

Abstract

Many studies in macroeconomics argue that financial frictions do not amplify the impacts of real shocks. This finding is based on models without endogenous default on loans and bank capital. Using a model featuring endogenous interactions between firm default and bank capital, this paper revisits the propagation mechanisms of real and financial shocks. The model, calibrated to the US economy, shows that real shocks translate into a financial problem and cause persistent business cycle fluctuations through countercyclical firm default and interest-rate spread. Consistent with the previous studies, financial shocks lead the economy into booms and recessions, notably during the US financial crisis. Capital injections to banks through the Troubled Asset Relief Program were an effective policy response for mitigating the vicious cycle between loan default and interest-rate spread.

Suggested Citation

  • Tamon Takamura, 2013. "Real-financial Linkages through Loan Default and Bank Capital," Staff Working Papers 13-3, Bank of Canada.
  • Handle: RePEc:bca:bocawp:13-3
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    References listed on IDEAS

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    6. Meh, Césaire A. & Moran, Kevin, 2010. "The role of bank capital in the propagation of shocks," Journal of Economic Dynamics and Control, Elsevier, vol. 34(3), pages 555-576, March.
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    Cited by:

    1. Auray, Stéphane & Eyquem, Aurélien & Ma, Xiaofei, 2018. "Banks, sovereign risk and unconventional monetary policies," European Economic Review, Elsevier, vol. 108(C), pages 153-171.
    2. Diniz, Andre & Guimaraes, Bernardo, 2014. "Financial disruption as a cost of sovereign default: a quantitative assessment," LSE Research Online Documents on Economics 86329, London School of Economics and Political Science, LSE Library.

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    More about this item

    Keywords

    Financial institutions; Financial stability; Financial system regulation and policies; Interest rates;
    All these keywords.

    JEL classification:

    • E3 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook
    • E69 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Other

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