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Asset prices and banking distress: a macroeconomic approach

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  • Goetz von Peter

Abstract

This paper links banking with asset prices in a monetary macroeconomic model. The main innovation is to consider how falling asset prices affect the banking system through wide-spread borrower default, while deriving explicit solutions and balance sheet effects even far from the steady state. We find that the effect of falling asset prices is indirect, non-linear, and involves feedback from the banking system in the form of a credit contraction. When borrowers repay, the effect 'passes through' the bank balance sheet; once borrowers default, asset prices drive bank capital, and constrained credit in turn drives asset prices. This interaction can explain capital crunches, financial instability, and banking crises, either as fundamental or as self-fulfilling outcomes. This model, unlike others, distinguishes between financial and macroeconomic stability, and makes precise the notion of balance sheet vulnerability. It also carries regulatory implications and adds to the debate on asset prices and monetary policy. The case studies apply the model to Japan's Lost Decade, the Nordic Banking Crises, and the US Great Depression.

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  • Goetz von Peter, 2004. "Asset prices and banking distress: a macroeconomic approach," BIS Working Papers 167, Bank for International Settlements.
  • Handle: RePEc:bis:biswps:167
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    More about this item

    Keywords

    Banking; Asset Prices; Inside Money; Default; Non-Performing Loans; Capital Requirements; Credit Crunch; Financial Instability; Banking Crisis; Vulnerability;
    All these keywords.

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • 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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