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Credit Frictions, Collateral and the Cyclical Behaviour of the Finance Premium

Abstract

This paper examines the behaviour of the finance premium following technology and monetary shocks in a Dynamic Stochastic General Equilibrium (DSGE) model where borrowers use a fraction of their production (output) as collateral. We show that this simple framework is capable of producing a countercyclical finance premium, while matching the macro dynamics of well-documented stylized facts. A key feature is the endogenous derivation of the default probability from break even conditions, that results in the loan rate being set as a countercyclical finance premium over the cost of borrowing from the central bank. The latter is shown to provide an accelerator effect through which shocks can amplify the loan spread and the dynamic response of macro variables.

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File URL: http://www.socialsciences.manchester.ac.uk/medialibrary/cgbcr/discussionpapers/dpcgbcr172.pdf
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Paper provided by Economics, The Univeristy of Manchester in its series Centre for Growth and Business Cycle Research Discussion Paper Series with number 172.

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Length: 20 pages
Date of creation: 2012
Date of revision:
Handle: RePEc:man:cgbcrp:172
Contact details of provider: Postal: Manchester M13 9PL
Phone: (0)161 275 4868
Fax: (0)161 275 4812
Web page: http://www.socialsciences.manchester.ac.uk/subjects/economics/our-research/centre-for-growth-and-business-cycle-research/
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  1. Ferre De Graeve, 2008. "The external finance premium and the macroeconomy: US post-WWII evidence," Working Papers 0809, Federal Reserve Bank of Dallas.
  2. Tommaso Monacelli & Ester Faia, 2005. "Optimal Interest Rate Rules, Asset Prices and Credit Frictions," Computing in Economics and Finance 2005 452, Society for Computational Economics.
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Cited by:

  1. Stefania Villa, 2014. "Financial frictions in the Euro Area and the United States: a Bayesian assessment," BCAM Working Papers 1407, Birkbeck Centre for Applied Macroeconomics.
  2. William Tayler & Roy Zilberman, 2014. "Macroprudential regulation and the role of monetary policy," Working Papers 63933064, Lancaster University Management School, Economics Department.
  3. Airaudo, Marco & Olivero, María Pía, 2014. "Optimal Monetary Policy with Counter-Cyclical Credit Spreads," School of Economics Working Paper Series 2014-1, LeBow College of Business, Drexel University.
  4. Roy Zilberman & William Tayler, 2014. "Financial shocks, loan loss provisions and macroeconomic stability," Working Papers 68464009, Lancaster University Management School, Economics Department.
  5. George J. Bratsiotis & William J. Tayler & Roy Zilberman, 2014. "Financial Regulation, Credit and Liquidity Policy and the Business Cycle," Centre for Growth and Business Cycle Research Discussion Paper Series 196, Economics, The Univeristy of Manchester.
  6. George J. Bratsiotis & Wayne A. Robinson, 2014. "Unit Total Costs: An Alternative Marginal Cost Proxy for Inflation Dynamics," Centre for Growth and Business Cycle Research Discussion Paper Series 192, Economics, The Univeristy of Manchester.

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