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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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File URL: http://mpra.ub.uni-muenchen.de/39648/1/MPRA_paper_39648.pdf
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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
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Handle: RePEc:pra:mprapa:39648
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  1. Frank Smets & Raf Wouters, 2007. "Shocks and Frictions in US Business Cycles : a Bayesian DSGE Approach," Working Paper Research 109, National Bank of Belgium.
  2. Lasse Heje Pederson & Markus K Brunnermeier, 2007. "Market Liquidity and Funding Liquidity," FMG Discussion Papers dp580, Financial Markets Group.
  3. Nobuhiro Kiyotaki & John Moore, 1995. "Credit Cycles," NBER Working Papers 5083, National Bureau of Economic Research, Inc.
  4. Holmström, Bengt & Tirole, Jean, 1994. "Financial Intermediation, Loanable Funds and the Real Sector," IDEI Working Papers 40, Institut d'Économie Industrielle (IDEI), Toulouse.
  5. Ajello, Andrea, 2010. "Financial intermediation, investment dynamics and business cycle fluctuations," MPRA Paper 32447, University Library of Munich, Germany, revised Mar 2011.
  6. Lawrence J. Christiano & Martin Eichenbaum & Charles Evans, 2001. "Nominal rigidities and the dynamic effects of a shock to monetary policy," Proceedings, Federal Reserve Bank of San Francisco, issue Jun.
  7. Césaire Meh & Kevin Moran, 2008. "The Role of Bank Capital in the Propagation of Shocks," Working Papers 08-36, Bank of Canada.
  8. (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.
  9. Mark Gertler & Simon Gilchrist & Fabio Natalucci, 2001. "External constraints on monetary policy and the financial accelerator," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
  10. 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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  14. repec:dgr:kubcen:2010108s is not listed on IDEAS
  15. Simon Gilchrist & Egon Zakrajšek, 2011. "Monetary Policy and Credit Supply Shocks," IMF Economic Review, Palgrave Macmillan, vol. 59(2), pages 195-232, June.
  16. Mark A. Carlson & Thomas B. King & Kurt F. Lewis, 2008. "Distress in the financial sector and economic activity," Finance and Economics Discussion Series 2008-43, Board of Governors of the Federal Reserve System (U.S.).
  17. Angeloni, Ignazio & Faia, Ester, 2013. "Capital regulation and monetary policy with fragile banks," Journal of Monetary Economics, Elsevier, vol. 60(3), pages 311-324.
  18. 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.
  19. Gomme, Paul & Ravikumar, B & Rupert, Peter, 2007. "The Return to Capital and the Business Cycle," University of California at Santa Barbara, Economics Working Paper Series qt8d5824r7, Department of Economics, UC Santa Barbara.
  20. Vladimir Yankov & Egon Zakrajsek & Simon Gilchrist, 2009. "Credit Market Shocks and Economic Fluctuations: Evidence from Corporate Bond and Stock Markets," 2009 Meeting Papers 514, Society for Economic Dynamics.
  21. Robert J. Barro & Robert G. King, 1982. "Time-Separable Preference and Intertemporal-Substitution Models of Business Cycles," NBER Working Papers 0888, National Bureau of Economic Research, Inc.
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