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Imperfect Banking Competition and Macroeconomic Volatility: A DSGE Framework

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  • Jiaqi Li

Abstract

This paper studies the impact of imperfect banking competition on aggregate fluctuations using a DSGE framework that features a Cournot banking sector. The paper highlights a new propagation mechanism of imperfect banking competition that operates via the dynamics of the expected marginal product of capital. Since capital is partly financed by bank loans, a higher expected return on capital implies that firms are more willing to borrow to invest in capital, making their capital and thus loan demand more inelastic. Market power enables banks to take advantage of the lower loan demand elasticity by charging a higher loan rate markup. Given that different shocks affect the dynamics of the expected return on capital differently, this paper finds that while the loan rate markup after a contractionary monetary policy shock increases and thus amplifies aggregate fluctuations, the impact of imperfect banking competition after a productivity shock is less clear and depends on the persistence of the shock.

Suggested Citation

  • Jiaqi Li, 2021. "Imperfect Banking Competition and Macroeconomic Volatility: A DSGE Framework," Staff Working Papers 21-12, Bank of Canada.
    • Handle: RePEc:bca:bocawp:21-12
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    References listed on IDEAS

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    As found by EconAcademics.org, the blog aggregator for Economics research:
    1. Imperfect Banking Competition and Macroeconomic Volatility: A DSGE Framework
      by Christian Zimmermann in NEP-DGE blog on 2021-03-15 15:55:09

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    More about this item

    Keywords

    Business fluctuations and cycles; Financial institutions; Interest rates;
    All these keywords.

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • L13 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Oligopoly and Other Imperfect Markets

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