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Leverage Restrictions in a Business Cycle Model

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  • Lawrence Christiano
  • Daisuke Ikeda

Abstract

We modify an otherwise standard medium-sized DSGE model, in order to study the macroeconomic effects of placing leverage restrictions on financial intermediaries. The financial intermediaries (`bankers') in the model must exert effort in order to earn high returns for their creditors. An agency problem arises because banker effort is not observable to creditors. The consequence of this agency problem is that leverage restrictions on banks generate a very substantial welfare gain in steady state. We discuss the economics of this gain. As a way of testing the model, we explore its implications for the dynamic effects of shocks.

Suggested Citation

  • Lawrence Christiano & Daisuke Ikeda, 2014. "Leverage Restrictions in a Business Cycle Model," Working Papers Central Bank of Chile 726, Central Bank of Chile.
  • Handle: RePEc:chb:bcchwp:726
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    References listed on IDEAS

    as
    1. Erceg, Christopher J. & Henderson, Dale W. & Levin, Andrew T., 2000. "Optimal monetary policy with staggered wage and price contracts," Journal of Monetary Economics, Elsevier, vol. 46(2), pages 281-313, October.
    2. Saki Bigio, 2012. "Financial Risk Capacity," 2012 Meeting Papers 97, Society for Economic Dynamics.
    3. Merz, Monika, 1995. "Search in the labor market and the real business cycle," Journal of Monetary Economics, Elsevier, vol. 36(2), pages 269-300, November.
    4. Tobias Adrian & Paolo Colla & Hyun Song Shin, 2013. "Which Financial Frictions? Parsing the Evidence from the Financial Crisis of 2007 to 2009," NBER Macroeconomics Annual, University of Chicago Press, vol. 27(1), pages 159-214.
    5. Tobias Adrian & Paolo Colla & Hyun Song Shin, 2012. "Which Financial Frictions? Parsing the Evidence from the Financial Crisis of 2007-9," NBER Working Papers 18335, National Bureau of Economic Research, Inc.
    6. Matthias Kehrig, 2011. "The Cyclicality of Productivity Dispersion," 2011 Meeting Papers 484, Society for Economic Dynamics.
    7. Gertler, Mark & Kiyotaki, Nobuhiro & Queralto, Albert, 2012. "Financial crises, bank risk exposure and government financial policy," Journal of Monetary Economics, Elsevier, vol. 59(S), pages 17-34.
    Full references (including those not matched with items on IDEAS)

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    Blog mentions

    As found by EconAcademics.org, the blog aggregator for Economics research:
    1. Leverage Restrictions in a Business Cycle Model
      by Christian Zimmermann in NEP-DGE blog on 2014-07-11 19:12:22

    Citations

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    Cited by:

    1. Galip Kemal Ozhan, 2015. "Financial Intermediation, Resource Allocation, and Macroeconomic Interdependence," 2015 Papers poz71, Job Market Papers.
    2. Gertler, M. & Kiyotaki, N. & Prestipino, A., 2016. "Wholesale Banking and Bank Runs in Macroeconomic Modeling of Financial Crises," Handbook of Macroeconomics, Elsevier.
    3. Giorgio Primiceri & Andrea Tambalotti & Alejandro Justiniano, 2014. "Credit Supply and the Housing Boom," 2014 Meeting Papers 766, Society for Economic Dynamics.
    4. Laurent Clerc & Alexis Derviz & Caterina Mendicino & Stephane Moyen & Kalin Nikolov & Livio Stracca & Javier Suarez & Alexandros P. Vardoulakis, 2015. "Capital Regulation in a Macroeconomic Model with Three Layers of Default," International Journal of Central Banking, International Journal of Central Banking, vol. 11(3), pages 9-63, June.
    5. Thomas Brand & Fabien Tripier, 2014. "Risk shocks and divergence between the Euro area and the US," Working Papers 2014-11, CEPII research center.
    6. Kühl, Michael, 2014. "Mitigating financial stress in a bank-financed economy: Equity injections into banks or purchases of assets?," Discussion Papers 19/2014, Deutsche Bundesbank.
    7. Lawrence Christiano & Roberto Motto & Massimo Rostagno, 2013. "Risk Shocks," NBER Working Papers 18682, National Bureau of Economic Research, Inc.
    8. Chen, kaiji & Zha, Tao, 2015. "Assessing the macroeconomic impact of bank intermediation shocks: a structural approach," FRB Atlanta Working Paper 2015-8, Federal Reserve Bank of Atlanta.
    9. Yoo, Jinhyuk, 2017. "Capital injection to banks versus debt relief to households," IMFS Working Paper Series 111, Goethe University Frankfurt, Institute for Monetary and Financial Stability (IMFS).
    10. Benes, Jaromir & Kumhof, Michael, 2015. "Risky bank lending and countercyclical capital buffers," Journal of Economic Dynamics and Control, Elsevier, vol. 58(C), pages 58-80.
    11. Carrillo Julio A. & Poilly Céline, 2010. "Investigating the Zero Lower Bound on the Nominal Interest Rate under Financial Instability," Research Memorandum 019, Maastricht University, Maastricht Research School of Economics of Technology and Organization (METEOR).
    12. Ferrante, Francesco, 2015. "A Model of Endogenous Loan Quality and the Collapse of the Shadow Banking System," Finance and Economics Discussion Series 2015-21, Board of Governors of the Federal Reserve System (US).
    13. Dany, Geraldine, 2016. "The credit channel during times of financial stress: A time varying VAR analysis," Annual Conference 2016 (Augsburg): Demographic Change 145899, Verein für Socialpolitik / German Economic Association.
    14. Schleer, Frauke & Semmler, Willi & Illner, Julian, 2014. "Overleveraging in the banking sector: Evidence from Europe," ZEW Discussion Papers 14-066, ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research.
    15. Juliane M. Begenau, 2015. "Capital Requirements, Risk Choice, and Liquidity Provision in a Business Cycle Model," Harvard Business School Working Papers 15-072, Harvard Business School, revised Sep 2016.
    16. Gross, Marco & Henry, Jérôme & Semmler, Willi, 2017. "Destabilizing effects of bank overleveraging on real activity - an analysis based on a threshold MCS-GVAR," Working Paper Series 2081, European Central Bank.
    17. Tirupam Goel, 2016. "Banking industry dynamics and size-dependent capital regulation," BIS Working Papers 599, Bank for International Settlements.
    18. Chen, Kaiji & Ren, Jue & Zha, Tao, 2016. "What we learn from China's rising shadow banking: exploring the nexus of monetary tightening and banks' role in entrusted lending," FRB Atlanta Working Paper 2016-1, Federal Reserve Bank of Atlanta.
    19. Foulis, Angus & Nelson, Benjamin & Tanaka, Misa, 2015. "Bank leverage, credit traps and credit policies," Bank of England working papers 539, Bank of England.
    20. Cesa-Bianchi, Ambrogio & Fernandez-Corugedo, Emilio, 2014. "Uncertainty in a model with credit frictions," Bank of England working papers 496, Bank of England.
    21. Juliane Begenau, 2015. "Capital Requirements, Risk Choice, and Liquidity Provision in a Business Cycle Model," 2015 Meeting Papers 687, Society for Economic Dynamics.

    More about this item

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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