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Financial intermediaries, credit Shocks and business cycles

  • Mimir, Yasin

This paper conducts a quantitative analysis of the role of financial shocks and credit frictions affecting the banking sector in driving U.S. business cycles. I first document three key business cycle stylized facts of aggregate financial variables in the U.S. banking sector: (i) Bank credit, deposits and loan spread are less volatile than output, while net worth and leverage ratio are more volatile, (ii) bank credit and net worth are procyclical, while deposits, leverage ratio and loan spread are countercyclical, and (iii) financial variables lead the output fluctuations by one to three quarters. I then present an equilibrium business cycle model with a financial sector, featuring a moral hazard problem between banks and its depositors, which leads to endogenous capital constraints for banks in obtaining funds from households. The model incorporates empirically-disciplined shocks to bank net worth (i.e. "financial shocks") that alter the ability of banks to borrow and to extend credit to non-financial businesses. I show that the benchmark model is able to deliver most of the above stylized facts. Financial shocks and credit frictions in banking sector are important not only for explaining the dynamics of financial variables but also for the dynamics of standard macroeconomic variables. Financial shocks play a major role in driving real fluctuations due to their impact on the tightness of bank capital constraint and the credit spread.

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 39648.

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Date of creation: May 2012
Date of revision:
Handle: RePEc:pra:mprapa:39648
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  1. Simon Gilchrist & Egon Zakrajšek, 2011. "Monetary Policy and Credit Supply Shocks," IMF Economic Review, Palgrave Macmillan, vol. 59(2), pages 195-232, June.
  2. (Kim | Lopez-Salido | Swanson) & Andrew Levin, 2004. "The magnitude and Cyclical Behavior of Financial Market Frictions," Computing in Economics and Finance 2004 224, Society for Computational Economics.
  3. 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.
  4. Korajczyk, Robert A. & Levy, Amnon, 2003. "Capital structure choice: macroeconomic conditions and financial constraints," Journal of Financial Economics, Elsevier, vol. 68(1), pages 75-109, April.
  5. Smets, Frank & Wouters, Rafael, 2007. "Shocks and Frictions in US Business Cycles: A Bayesian DSGE Approach," CEPR Discussion Papers 6112, C.E.P.R. Discussion Papers.
  6. Lasse Heje Pederson & Markus K Brunnermeier, 2007. "Market Liquidity and Funding Liquidity," FMG Discussion Papers dp580, Financial Markets Group.
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  8. Carlson Mark A & King Thomas & Lewis Kurt, 2011. "Distress in the Financial Sector and Economic Activity," The B.E. Journal of Economic Analysis & Policy, De Gruyter, vol. 11(1), pages 1-31, June.
  9. Tobias Adrian & Hyun Song Shin, 2008. "Liquidity and leverage," Staff Reports 328, Federal Reserve Bank of New York.
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  12. Paul Gomme & B. Ravikumar & Peter Rupert, 2008. "The Return to Capital and the Business Cycle," Working Papers 08002, Concordia University, Department of Economics, revised 23 Sep 2010.
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  14. repec:oup:qjecon:v:99:y:1984:i:4:p:817-39 is not listed on IDEAS
  15. Hancock, Diana & Laing, Andrew J. & Wilcox, James A., 1995. "Bank capital shocks: Dynamic effects on securities, loans, and capital," Journal of Banking & Finance, Elsevier, vol. 19(3-4), pages 661-677, June.
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  17. Ajello, Andrea, 2010. "Financial intermediation, investment dynamics and business cycle fluctuations," MPRA Paper 32447, University Library of Munich, Germany, revised Mar 2011.
  18. Gertler, Mark & Karadi, Peter, 2011. "A model of unconventional monetary policy," Journal of Monetary Economics, Elsevier, vol. 58(1), pages 17-34, January.
  19. Simon Gilchrist & Vladimir Yankov & Egon Zakrajsek, 2009. "Credit Market Shocks and Economic Fluctuations: Evidence from Corporate Bond and Stock Markets," NBER Working Papers 14863, National Bureau of Economic Research, Inc.
  20. Lawrence J. Christiano & Martin Eichenbaum & Charles Evans, 2001. "Nominal Rigidities and the Dynamic Effects of a Shock to Monetary Policy," NBER Working Papers 8403, National Bureau of Economic Research, Inc.
  21. Francisco Covas & Wouter J. Den Haan, 2011. "The Cyclical Behavior of Debt and Equity Finance," American Economic Review, American Economic Association, vol. 101(2), pages 877-99, April.
  22. Kevin C. Murdock & Thomas F. Hellmann & Joseph E. Stiglitz, 2000. "Liberalization, Moral Hazard in Banking, and Prudential Regulation: Are Capital Requirements Enough?," American Economic Review, American Economic Association, vol. 90(1), pages 147-165, March.
  23. Angeloni, Ignazio & Faia, Ester, 2013. "Capital regulation and monetary policy with fragile banks," Journal of Monetary Economics, Elsevier, vol. 60(3), pages 311-324.
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