Financial Intermediaries, Credit Shocks and Business Cycles

I document key business cycle facts of aggregate financial flows 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 real business cycle model with a financial sector, that is capable of matching these newly documented stylized facts. An agency problem between banks and their depositors induces endogenous capital constraints for banks in obtaining funds from households. Empirically-disciplined shocks to bank net worth alter the ability of banks to borrow and to extend credit to firms. I find that these financial shocks are important not only for explaining the dynamics of financial flows but also for the dynamics of standard macroeconomic aggregates. They play a major role in driving real fluctuations due to their impact on the tightness of bank capital constraint and the credit spread. The tightness measure of credit conditions in the model tracks the index of tightening credit standards constructed by the Federal Reserve Board quite well.