This paper introduces an imperfectly competitive banking sector into a DSGE model to study the role of credit supply factors in business cycle fluctuations in the euro area. Banks issue loans to households and firms, obtain funding via deposits, and accumulate capital from retained earnings. Margins on loans depend on bank capital ratios and interest rate stickiness. Estimating the model with euro area data from 1999-2008, the paper finds that:
1) Shocks originating in the banking sector explain most of the output fall in 2008, while macroeconomic shocks played a smaller role.
2) An unexpected reduction in bank capital can significantly impact the real economy, especially investment.
3) Financial frictions amplify monetary policy effects,
This summary provides the key points from the document in 3 sentences:
The document discusses a study that investigates the determinants of bank lending behavior in Ghana. Using an econometric model, the study finds that bank size, capital structure, and competition have a positive relationship with bank lending, while macroeconomic indicators like interest rates and exchange rates negatively impact lending. The study contributes to understanding how bank-specific, macroeconomic, and industry factors influence bank lending decisions in an emerging market context like Ghana.
This document summarizes a study that examined the determinants of commercial bank lending in Ethiopia between 2005-2011. The study tested whether bank size, credit risk, GDP, investment, deposit, interest rate, liquidity ratio, and cash reserve requirements influenced bank lending. It found that bank size, credit risk, GDP, and liquidity ratio had a significant relationship with lending, but deposit, investment, interest rate, and cash reserves did not. The study suggests banks focus on managing credit risk and liquidity to support lending.
This document discusses empirical research on the determinants of bank lending across countries. It proposes estimating equations to model domestic credit levels based on bank balance sheet and capital requirements approaches. The analysis will use data from 146 countries over 1990-2013 to examine how economic growth, banking system health, and external capital flows influence domestic credit after controlling for other factors. Key determinants expected to impact credit include deposits, interest rates, costs, capital levels, and macroeconomic conditions.
This document summarizes a study that investigated the determinants of commercial bank lending behavior in Nigeria. The study aimed to test how common factors like deposits, investments, interest rates, reserve requirements, and liquidity ratios affect bank lending. Regression analysis found the model to be significant, with deposits having the greatest impact on lending. The study suggests banks focus on deposit mobilization to enhance lending performance and develop strategic plans.
This document summarizes a research paper that analyzed the determinants of credit risk in the Indonesian banking industry. Specifically, it examined how bank-specific variables like bank size, profitability, capital adequacy, and ownership structure influence the level of non-performing loans (NPL), which is used as a measure of credit risk. The document reviews several previous studies that also analyzed the relationship between credit risk and bank-specific factors in other countries. It then outlines the methodology that will be used in the research, including the data collection and analysis methods.
This thesis investigates the determinants of lending behavior among commercial banks in Ethiopia. The author conducted a case study of eight commercial banks over the period of 2001 to 2013. Through a panel data regression analysis, the author found that deposit volume and bank size had a positive and significant impact on loans and advances. Liquidity ratio and interest rate had a negative and significant impact. Cash reserve requirements and inflation rate had a positive impact, though the relationship was unexpected. GDP growth did not have a statistically significant impact. The study suggests commercial banks focus on deposit mobilization to enhance lending.
Determinants of commercial banks lending evidence from ethiopian commercial b...Alexander Decker
This document summarizes a study that examined the determinants of commercial bank lending in Ethiopia between 2005-2011. The study tested whether bank size, credit risk, GDP, investment, deposit, interest rate, liquidity ratio, and cash reserve requirements influenced bank lending. It found that bank size, credit risk, GDP, and liquidity ratio had a significant relationship with lending, but deposit, investment, interest rate, and cash reserves did not. The study suggests banks focus on managing credit risk and liquidity to support lending.
This document summarizes a theoretical model examining the effects of small regional banks on local economic growth. The model shows that small regional banks are more effective than large interregional banks at promoting economic growth in underdeveloped regions. This is because small regional banks have lower screening and monitoring costs of local borrowers compared to large banks. The model is then empirically tested using bank and regional economic data from Germany, finding that small regional banks play an important role in enhancing economic development in less developed German regions.
This summary provides the key points from the document in 3 sentences:
The document discusses a study that investigates the determinants of bank lending behavior in Ghana. Using an econometric model, the study finds that bank size, capital structure, and competition have a positive relationship with bank lending, while macroeconomic indicators like interest rates and exchange rates negatively impact lending. The study contributes to understanding how bank-specific, macroeconomic, and industry factors influence bank lending decisions in an emerging market context like Ghana.
This document summarizes a study that examined the determinants of commercial bank lending in Ethiopia between 2005-2011. The study tested whether bank size, credit risk, GDP, investment, deposit, interest rate, liquidity ratio, and cash reserve requirements influenced bank lending. It found that bank size, credit risk, GDP, and liquidity ratio had a significant relationship with lending, but deposit, investment, interest rate, and cash reserves did not. The study suggests banks focus on managing credit risk and liquidity to support lending.
This document discusses empirical research on the determinants of bank lending across countries. It proposes estimating equations to model domestic credit levels based on bank balance sheet and capital requirements approaches. The analysis will use data from 146 countries over 1990-2013 to examine how economic growth, banking system health, and external capital flows influence domestic credit after controlling for other factors. Key determinants expected to impact credit include deposits, interest rates, costs, capital levels, and macroeconomic conditions.
This document summarizes a study that investigated the determinants of commercial bank lending behavior in Nigeria. The study aimed to test how common factors like deposits, investments, interest rates, reserve requirements, and liquidity ratios affect bank lending. Regression analysis found the model to be significant, with deposits having the greatest impact on lending. The study suggests banks focus on deposit mobilization to enhance lending performance and develop strategic plans.
This document summarizes a research paper that analyzed the determinants of credit risk in the Indonesian banking industry. Specifically, it examined how bank-specific variables like bank size, profitability, capital adequacy, and ownership structure influence the level of non-performing loans (NPL), which is used as a measure of credit risk. The document reviews several previous studies that also analyzed the relationship between credit risk and bank-specific factors in other countries. It then outlines the methodology that will be used in the research, including the data collection and analysis methods.
This thesis investigates the determinants of lending behavior among commercial banks in Ethiopia. The author conducted a case study of eight commercial banks over the period of 2001 to 2013. Through a panel data regression analysis, the author found that deposit volume and bank size had a positive and significant impact on loans and advances. Liquidity ratio and interest rate had a negative and significant impact. Cash reserve requirements and inflation rate had a positive impact, though the relationship was unexpected. GDP growth did not have a statistically significant impact. The study suggests commercial banks focus on deposit mobilization to enhance lending.
Determinants of commercial banks lending evidence from ethiopian commercial b...Alexander Decker
This document summarizes a study that examined the determinants of commercial bank lending in Ethiopia between 2005-2011. The study tested whether bank size, credit risk, GDP, investment, deposit, interest rate, liquidity ratio, and cash reserve requirements influenced bank lending. It found that bank size, credit risk, GDP, and liquidity ratio had a significant relationship with lending, but deposit, investment, interest rate, and cash reserves did not. The study suggests banks focus on managing credit risk and liquidity to support lending.
This document summarizes a theoretical model examining the effects of small regional banks on local economic growth. The model shows that small regional banks are more effective than large interregional banks at promoting economic growth in underdeveloped regions. This is because small regional banks have lower screening and monitoring costs of local borrowers compared to large banks. The model is then empirically tested using bank and regional economic data from Germany, finding that small regional banks play an important role in enhancing economic development in less developed German regions.
The Back-door Nationalisation of Commercial Banks: Is It a Good Solution? Ca...TrHanna
This document provides a case study analysis of the UK government's nationalization of Northern Rock bank during the 2007-2009 financial crisis. It first discusses the causes and impacts of the financial crisis. It then examines Northern Rock's specific vulnerabilities, including its high reliance on short-term funding and high leverage. The document evaluates the UK government's options to intervene, including liquidation, raising new capital, takeover, bailout, and nationalization. It argues that nationalization was the best solution, as it had fewer drawbacks than the alternatives and allowed the government to oversee the bank's operations and risk-taking. The document aims to assess whether nationalization is an effective policy tool for addressing banking crises.
Macroeconomic and industry determinants of interest rate spread empirical evi...Alexander Decker
This document summarizes a study that examines the bank-specific, industry-specific, and macroeconomic factors that influence interest rate spreads in Ghanaian commercial banks from 1990 to 2010. The study uses data from 33 commercial banks over this 21-year period. Key findings include that interest rate spreads are significantly influenced by bank ownership, management efficiency, GDP per capita, and government securities. Government borrowing also influences spreads but has a negative effect. The paper aims to identify important determinants of interest rate spreads for central banks, commercial banks, and economic managers in Ghana.
Understanding Risk Management and Compliance, May 2012Compliance LLC
The document discusses several topics related to banking regulation:
1) It discusses the EBA's work over the past year to strengthen bank capital positions in response to the financial crisis, including stress tests and recommendations to raise over €115 billion in capital.
2) It outlines the EBA's goal of establishing a Single Rulebook to harmonize banking rules across the EU and prevent a relaxation of standards.
3) It focuses on the EBA's work developing regulatory technical standards for defining bank capital and ensuring high quality capital instruments are used across all member states.
Ana Gouveia - Financial Policies, financial systems and productivity - Discus...Structuralpolicyanalysis
This document summarizes discussions from a conference on weak productivity and the role of financial factors and policies. It discusses four academic papers and their findings. The first paper finds that restricted credit availability due to the financial crisis led to increased business failure, especially for highly leveraged firms. The second paper finds that weak banks and high firm leverage reduced investment, and this effect was stronger for firms linked to weak banks with high rollover risk. The third paper finds that loose monetary policy increased productivity growth by alleviating credit constraints, while quantitative easing reduced productivity growth. The document then discusses insights from research on Portugal, including definitions of weak banks, mechanisms like the link between weak banks and zombie firms, non-linear effects of leverage on investment
This bachelor thesis examines the key determinants of shadow banking systems in the Euro area, United Kingdom, and United States. The author builds a measure of shadow banking from a European perspective and analyzes the relationship between the shadow banking measure and several macroeconomic and financial variables. Regression analysis is conducted on two models - a base model including GDP, institutional investor assets, term spread, bank net interest margin, and liquidity, and an extended model which adds a systemic stress indicator, banking concentration index, and inflation. The analysis finds significant geographical differences in the relationships between shadow banking and the explanatory variables within the Euro area. Specifically, for some countries shadow banking grows as GDP, term spread, and liquidity increase, while for other countries
This document summarizes a research paper that develops a dynamic stochastic general equilibrium (DSGE) model to explain how monetary policy affects risk in financial markets and the macroeconomy. The key feature of the model is that asset and goods markets are segmented because it is costly for households to transfer funds between the markets. The model generates endogenous movements in risk as the fraction of households that rebalance their portfolios varies over time in response to real and monetary shocks. Simulation results indicate the model can account for evidence that monetary policy easing reduces equity premiums and helps explain the response of stock prices to monetary shocks.
This document summarizes a paper that develops a framework to study the effects of foreign competition on Mexico's banking industry dynamics and welfare. It applies the framework to analyze Mexico's banking industry in the 1990s, which underwent major changes as foreign restrictions were lifted. The model considers strategic interaction between domestic and foreign banks, and allows calibration to Mexican data to examine the welfare impacts of policies promoting global competition. It finds modest household welfare gains and substantial business gains from increased foreign participation in Mexico's banking sector.
Filippos Petroulakis - Discussion on “Financial frictions and within firm per...Structuralpolicyanalysis
This document summarizes discussions from a conference on financial factors and productivity. It discusses three papers that found credit frictions have significant negative impacts on firm productivity. More bank forbearance during crises leads to less "cleansing" of unproductive firms but also less growth after crises. While bank recapitalization aims to strengthen banks, it can also act like forbearance. The document discusses reconciling these results and their implications for policies that preserve credit supply.
1) The document examines how government intervention in the banking sector during financial crises affects long-term productivity.
2) It finds that higher regulatory forbearance (allowing struggling banks to remain open) reduces short-term economic losses but is negatively associated with post-crisis productivity growth, as it allows inefficient firms to remain in operation.
3) In contrast, tougher policies like bank restructuring that force struggling banks to close are found to yield higher long-term job creation, wages, and economic growth, suggesting financial crises can "cleanse" economies of inefficient firms and banks when governments take a stricter approach.
Newport legacy seoul korea the end of the banking boom will affect your retir...Katie Swift
The banking boom in Australia is coming to an end as new regulations and a challenging revenue environment take their toll on the major banks. Investment bank UBS has downgraded the four major Australian banks to a hold or sell rating. As banks face disruption from new technologies and the loss of their competitive advantage, their shareholders including superannuation funds will see lower returns. This could make it difficult for retirees relying on dividends to maintain their income levels.
The document summarizes and discusses three papers on the relationship between financial frictions, capital misallocation, and productivity. All three papers find different and innovative empirical evidence on this relationship. The discussion focuses on reconciling the different results, addressing open questions, and identifying areas where more work is needed, such as understanding differences between countries and the roles of banks, firm financial constraints, and credit supply shocks.
Stock market performance of some selected nigerian commercial banks amidst ec...Alexander Decker
This document summarizes a research study that assessed the stock market performance of selected Nigerian commercial banks from 2007 to 2010, a period of economic turbulence in Nigeria coinciding with the global financial crisis. The study examined stock price trends of 8 banks and whether performance differed between banks. It found that stock prices declined significantly from May 2008 for all banks. Banks facing financial troubles showed greater weakness in stock prices than healthy banks. The turbulence likely caused investors to lose confidence and reduce shareholdings. The study concluded that governments should act proactively to address threats to investment during periods of economic instability.
Mitigating the Deadly Embrace in Financial Cycles: Countercyclical Buffers an...Joannes Mongardini
IMF Working Paper WP/16/87 providing macroprudential simulations of the effectiveness of countercyclical buffers and loan-to-value limits to mitigate housing bubbles and bursts
Aitor Erce's discussion of "The Seniority Structure of Sovereign Debt"ADEMU_Project
- The paper presents two new datasets on sovereign debt: one on payment arrears by sovereign debtors to different creditor groups, and one on haircuts applied in sovereign debt restructurings to private and official creditors.
- Analyzing the datasets, the paper finds a clear pecking order among creditors, with multilateral institutions, bonds, bilateral loans, banks, and suppliers at the bottom in terms of seniority.
- The main policy conclusion is that the official sector should reconsider its approach to debt restructuring, as the analysis shows official creditors have become increasingly junior over time.
This document provides a summary of recent developments in global financial markets following the sub-prime mortgage crisis. It discusses how turmoil originated from problems in the US sub-prime mortgage market but was exacerbated by a liquidity crisis in the European inter-bank market. While central banks provided liquidity to stabilize markets, the document argues the current financial system's overreliance on complex, opaque instruments like CDOs and lack of transparency regarding risk has increased uncertainty and amplified volatility. Long-term regulatory reforms are needed to improve transparency and prevent excessive risk-taking.
Isabelle Roland - The Aggregate Eects of Credit Market Frictions: Evidence f...Structuralpolicyanalysis
This document presents the key findings of a study that develops a theoretical framework to quantify the impact of credit market frictions on aggregate output and productivity. The study assesses these impacts using firm-level data on employment and default risk from UK administrative surveys. The main findings are:
1) Credit market frictions substantially depressed UK output between 2004-2012, reducing it by 3-5% annually on average. This impact worsened during the financial crisis and lingered thereafter.
2) Credit frictions can explain 11-18% of the fall in UK productivity between 2008-2009 and 13-23% of the post-crisis productivity gap in 2012.
3) The results are mainly
This document summarizes a staff memo from Norges Bank that proposes a method for assessing credit risk on bank lending to corporations based on bankruptcy prediction modeling. The method estimates bankruptcy models for different industries using real-time economic indicators, credit ratings, and financial accounts data. It then assigns a risk weight to each firm's debt equal to its bankruptcy probability to estimate the share of debt that may end up in bankruptcy accounts. Comparing estimated risk-weighted debt to actual debt in bankruptcy accounts and bank losses historically shows good correspondence, indicating the model fits well.
This document provides an overview of a master's thesis that investigates the influence of shadow banking activity on real economic growth. The thesis uses a multivariate regression analysis with GDP growth as the dependent variable and shadow banking leverage growth as the main independent variable, along with several control variables. The results of the regression analysis do not confirm the hypothesis that shadow banking activity positively impacts economic growth. Specifically, the coefficient for the shadow banking proxy is found to be significantly negative. However, robustness tests show that this sign and significance do not hold firmly. Therefore, the data cannot clearly establish a significant relationship between shadow banking activity and real growth.
The 1990’s financial crises in Nordic countriesPeter Ho
The 1990s financial crises in the Nordic countries impacted Finland, Norway, and Sweden. All three countries experienced rapid growth and lending in the 1980s that led to overheating and current account deficits. This was followed by deep recessions in the early 1990s as asset and housing prices collapsed, unemployment rose, and banks faced huge losses. Finland's crisis was the most severe, with over 10% cumulative GDP decline. Public authorities had to provide significant support to stabilize the banking systems. The crises highlighted the risks of financial deregulation and overheating from excessive lending and asset price booms.
Lessons of the Financial Crisis for Future Regulation of Financial InstitutionsPeter Ho
The document summarizes lessons learned from the ongoing financial crisis for future regulation of financial institutions and markets. Key points include:
- The crisis exposed inadequacies in regulation, supervision, and risk management that failed to prevent excessive risk-taking. Reform is needed to address these issues.
- Priorities for reform include expanding regulation to new entities, addressing procyclicality of capital requirements, improving information sharing, resolving cross-border regulatory issues, and strengthening central bank liquidity management.
- International bodies like the FSF and G20 working groups are examining these issues and developing policy recommendations, but more work is still needed to implement reforms.
The Back-door Nationalisation of Commercial Banks: Is It a Good Solution? Ca...TrHanna
This document provides a case study analysis of the UK government's nationalization of Northern Rock bank during the 2007-2009 financial crisis. It first discusses the causes and impacts of the financial crisis. It then examines Northern Rock's specific vulnerabilities, including its high reliance on short-term funding and high leverage. The document evaluates the UK government's options to intervene, including liquidation, raising new capital, takeover, bailout, and nationalization. It argues that nationalization was the best solution, as it had fewer drawbacks than the alternatives and allowed the government to oversee the bank's operations and risk-taking. The document aims to assess whether nationalization is an effective policy tool for addressing banking crises.
Macroeconomic and industry determinants of interest rate spread empirical evi...Alexander Decker
This document summarizes a study that examines the bank-specific, industry-specific, and macroeconomic factors that influence interest rate spreads in Ghanaian commercial banks from 1990 to 2010. The study uses data from 33 commercial banks over this 21-year period. Key findings include that interest rate spreads are significantly influenced by bank ownership, management efficiency, GDP per capita, and government securities. Government borrowing also influences spreads but has a negative effect. The paper aims to identify important determinants of interest rate spreads for central banks, commercial banks, and economic managers in Ghana.
Understanding Risk Management and Compliance, May 2012Compliance LLC
The document discusses several topics related to banking regulation:
1) It discusses the EBA's work over the past year to strengthen bank capital positions in response to the financial crisis, including stress tests and recommendations to raise over €115 billion in capital.
2) It outlines the EBA's goal of establishing a Single Rulebook to harmonize banking rules across the EU and prevent a relaxation of standards.
3) It focuses on the EBA's work developing regulatory technical standards for defining bank capital and ensuring high quality capital instruments are used across all member states.
Ana Gouveia - Financial Policies, financial systems and productivity - Discus...Structuralpolicyanalysis
This document summarizes discussions from a conference on weak productivity and the role of financial factors and policies. It discusses four academic papers and their findings. The first paper finds that restricted credit availability due to the financial crisis led to increased business failure, especially for highly leveraged firms. The second paper finds that weak banks and high firm leverage reduced investment, and this effect was stronger for firms linked to weak banks with high rollover risk. The third paper finds that loose monetary policy increased productivity growth by alleviating credit constraints, while quantitative easing reduced productivity growth. The document then discusses insights from research on Portugal, including definitions of weak banks, mechanisms like the link between weak banks and zombie firms, non-linear effects of leverage on investment
This bachelor thesis examines the key determinants of shadow banking systems in the Euro area, United Kingdom, and United States. The author builds a measure of shadow banking from a European perspective and analyzes the relationship between the shadow banking measure and several macroeconomic and financial variables. Regression analysis is conducted on two models - a base model including GDP, institutional investor assets, term spread, bank net interest margin, and liquidity, and an extended model which adds a systemic stress indicator, banking concentration index, and inflation. The analysis finds significant geographical differences in the relationships between shadow banking and the explanatory variables within the Euro area. Specifically, for some countries shadow banking grows as GDP, term spread, and liquidity increase, while for other countries
This document summarizes a research paper that develops a dynamic stochastic general equilibrium (DSGE) model to explain how monetary policy affects risk in financial markets and the macroeconomy. The key feature of the model is that asset and goods markets are segmented because it is costly for households to transfer funds between the markets. The model generates endogenous movements in risk as the fraction of households that rebalance their portfolios varies over time in response to real and monetary shocks. Simulation results indicate the model can account for evidence that monetary policy easing reduces equity premiums and helps explain the response of stock prices to monetary shocks.
This document summarizes a paper that develops a framework to study the effects of foreign competition on Mexico's banking industry dynamics and welfare. It applies the framework to analyze Mexico's banking industry in the 1990s, which underwent major changes as foreign restrictions were lifted. The model considers strategic interaction between domestic and foreign banks, and allows calibration to Mexican data to examine the welfare impacts of policies promoting global competition. It finds modest household welfare gains and substantial business gains from increased foreign participation in Mexico's banking sector.
Filippos Petroulakis - Discussion on “Financial frictions and within firm per...Structuralpolicyanalysis
This document summarizes discussions from a conference on financial factors and productivity. It discusses three papers that found credit frictions have significant negative impacts on firm productivity. More bank forbearance during crises leads to less "cleansing" of unproductive firms but also less growth after crises. While bank recapitalization aims to strengthen banks, it can also act like forbearance. The document discusses reconciling these results and their implications for policies that preserve credit supply.
1) The document examines how government intervention in the banking sector during financial crises affects long-term productivity.
2) It finds that higher regulatory forbearance (allowing struggling banks to remain open) reduces short-term economic losses but is negatively associated with post-crisis productivity growth, as it allows inefficient firms to remain in operation.
3) In contrast, tougher policies like bank restructuring that force struggling banks to close are found to yield higher long-term job creation, wages, and economic growth, suggesting financial crises can "cleanse" economies of inefficient firms and banks when governments take a stricter approach.
Newport legacy seoul korea the end of the banking boom will affect your retir...Katie Swift
The banking boom in Australia is coming to an end as new regulations and a challenging revenue environment take their toll on the major banks. Investment bank UBS has downgraded the four major Australian banks to a hold or sell rating. As banks face disruption from new technologies and the loss of their competitive advantage, their shareholders including superannuation funds will see lower returns. This could make it difficult for retirees relying on dividends to maintain their income levels.
The document summarizes and discusses three papers on the relationship between financial frictions, capital misallocation, and productivity. All three papers find different and innovative empirical evidence on this relationship. The discussion focuses on reconciling the different results, addressing open questions, and identifying areas where more work is needed, such as understanding differences between countries and the roles of banks, firm financial constraints, and credit supply shocks.
Stock market performance of some selected nigerian commercial banks amidst ec...Alexander Decker
This document summarizes a research study that assessed the stock market performance of selected Nigerian commercial banks from 2007 to 2010, a period of economic turbulence in Nigeria coinciding with the global financial crisis. The study examined stock price trends of 8 banks and whether performance differed between banks. It found that stock prices declined significantly from May 2008 for all banks. Banks facing financial troubles showed greater weakness in stock prices than healthy banks. The turbulence likely caused investors to lose confidence and reduce shareholdings. The study concluded that governments should act proactively to address threats to investment during periods of economic instability.
Mitigating the Deadly Embrace in Financial Cycles: Countercyclical Buffers an...Joannes Mongardini
IMF Working Paper WP/16/87 providing macroprudential simulations of the effectiveness of countercyclical buffers and loan-to-value limits to mitigate housing bubbles and bursts
Aitor Erce's discussion of "The Seniority Structure of Sovereign Debt"ADEMU_Project
- The paper presents two new datasets on sovereign debt: one on payment arrears by sovereign debtors to different creditor groups, and one on haircuts applied in sovereign debt restructurings to private and official creditors.
- Analyzing the datasets, the paper finds a clear pecking order among creditors, with multilateral institutions, bonds, bilateral loans, banks, and suppliers at the bottom in terms of seniority.
- The main policy conclusion is that the official sector should reconsider its approach to debt restructuring, as the analysis shows official creditors have become increasingly junior over time.
This document provides a summary of recent developments in global financial markets following the sub-prime mortgage crisis. It discusses how turmoil originated from problems in the US sub-prime mortgage market but was exacerbated by a liquidity crisis in the European inter-bank market. While central banks provided liquidity to stabilize markets, the document argues the current financial system's overreliance on complex, opaque instruments like CDOs and lack of transparency regarding risk has increased uncertainty and amplified volatility. Long-term regulatory reforms are needed to improve transparency and prevent excessive risk-taking.
Isabelle Roland - The Aggregate Eects of Credit Market Frictions: Evidence f...Structuralpolicyanalysis
This document presents the key findings of a study that develops a theoretical framework to quantify the impact of credit market frictions on aggregate output and productivity. The study assesses these impacts using firm-level data on employment and default risk from UK administrative surveys. The main findings are:
1) Credit market frictions substantially depressed UK output between 2004-2012, reducing it by 3-5% annually on average. This impact worsened during the financial crisis and lingered thereafter.
2) Credit frictions can explain 11-18% of the fall in UK productivity between 2008-2009 and 13-23% of the post-crisis productivity gap in 2012.
3) The results are mainly
This document summarizes a staff memo from Norges Bank that proposes a method for assessing credit risk on bank lending to corporations based on bankruptcy prediction modeling. The method estimates bankruptcy models for different industries using real-time economic indicators, credit ratings, and financial accounts data. It then assigns a risk weight to each firm's debt equal to its bankruptcy probability to estimate the share of debt that may end up in bankruptcy accounts. Comparing estimated risk-weighted debt to actual debt in bankruptcy accounts and bank losses historically shows good correspondence, indicating the model fits well.
This document provides an overview of a master's thesis that investigates the influence of shadow banking activity on real economic growth. The thesis uses a multivariate regression analysis with GDP growth as the dependent variable and shadow banking leverage growth as the main independent variable, along with several control variables. The results of the regression analysis do not confirm the hypothesis that shadow banking activity positively impacts economic growth. Specifically, the coefficient for the shadow banking proxy is found to be significantly negative. However, robustness tests show that this sign and significance do not hold firmly. Therefore, the data cannot clearly establish a significant relationship between shadow banking activity and real growth.
The 1990’s financial crises in Nordic countriesPeter Ho
The 1990s financial crises in the Nordic countries impacted Finland, Norway, and Sweden. All three countries experienced rapid growth and lending in the 1980s that led to overheating and current account deficits. This was followed by deep recessions in the early 1990s as asset and housing prices collapsed, unemployment rose, and banks faced huge losses. Finland's crisis was the most severe, with over 10% cumulative GDP decline. Public authorities had to provide significant support to stabilize the banking systems. The crises highlighted the risks of financial deregulation and overheating from excessive lending and asset price booms.
Lessons of the Financial Crisis for Future Regulation of Financial InstitutionsPeter Ho
The document summarizes lessons learned from the ongoing financial crisis for future regulation of financial institutions and markets. Key points include:
- The crisis exposed inadequacies in regulation, supervision, and risk management that failed to prevent excessive risk-taking. Reform is needed to address these issues.
- Priorities for reform include expanding regulation to new entities, addressing procyclicality of capital requirements, improving information sharing, resolving cross-border regulatory issues, and strengthening central bank liquidity management.
- International bodies like the FSF and G20 working groups are examining these issues and developing policy recommendations, but more work is still needed to implement reforms.
This document summarizes initial lessons from the financial crisis in three areas: regulation, macroeconomic policy, and the global financial system. Key failures included fragmented regulation that allowed regulatory arbitrage, a lack of coordination between macro and financial stability policies, and an inability within the global system to identify vulnerabilities. Lessons indicate regulation needs broader oversight of all systemically important financial activities, macro policies should consider financial stability risks, and greater international cooperation is required.
This document provides an overview of the oil market in March 2009. It discusses the relative stability of crude oil prices despite continued economic uncertainties and downward revisions to oil demand forecasts. Global oil demand is expected to decline by 1.0 mb/d in 2009, with OECD seeing a decline of 1.3 mb/d. Non-OPEC supply is projected to increase by 0.4 mb/d in 2009. Required OPEC crude is projected to decrease by 1.8 mb/d in 2009 compared to 2008. The document also discusses movements in the OPEC Reference Basket price in February 2009 and issues to be considered at the upcoming OPEC conference.
STOCKTAKING OF THE G-20 RESPONSES TO THE GLOBAL BANKING CRISISPeter Ho
The document provides a preliminary assessment of policy responses by G-20 countries to address the global banking crisis from September 2008 to February 2009. It finds that initial responses were reactive and aimed at containment through measures like debt guarantees and liquidity support. Key limitations identified include inadequate creditor protection if economic conditions worsen, ad hoc capital injections, and a lack of frameworks for asset management. Going forward, the document recommends a more comprehensive and coordinated international strategy across four elements: coordination of restructuring policies, cooperation on toxic asset valuation and disposal, financial institution inspections, and frameworks for public ownership of banks.
The document discusses the bankruptcy discharge process. It explains that:
1) A bankruptcy discharge releases debtors from personal liability for certain debts and prohibits creditors from collecting on those debts. However, valid liens remain enforceable.
2) The timing of discharge varies by chapter, but generally occurs 4 months after filing for chapter 7 and after completing all payments under chapter 12 or 13 plans, which usually takes 3-5 years.
3) Not all debts are discharged - there are several categories of debt that are exempt from discharge for public policy reasons, such as certain taxes, debts from fraud or willful/malicious behavior, and student loans. Creditors must object to the discharge of other specified debts.
The document provides an overview and analysis of the global economic outlook by the IMF staff. It finds that:
1) Global economic activity has fallen sharply, with advanced economies experiencing their worst declines since World War 2.
2) The IMF forecasts that the global economy will contract by 0.5-1% in 2009 on average before a gradual recovery in 2010.
3) Turning the global economy around depends critically on concerted policy actions to stabilize financial conditions and support demand through fiscal and monetary policies.
The document provides an overview and analysis of China's economic developments in the first half of 2009. It discusses three main points:
1) While China's economy has continued to feel the effects of the global crisis, very expansionary fiscal and monetary policies have supported growth. Government investment has soared while market investment has lagged. Consumption has held up well.
2) Exports remain very weak but imports have recovered as stimulus has boosted demand for raw materials. GDP growth was a respectable 6% in the first quarter.
3) Downward pressure on inflation has continued as falling raw material prices drag down prices, but overcapacity is squeezing industry profits. Growth is projected to remain around 7%
This document provides a summary of new and revised IFRS standards and interpretations that will become effective in 2009. Key changes include revisions to IAS 1 regarding financial statement presentation, IAS 27 and IFRS 3 introducing a single consolidation model, and IFRS 8 bringing segment reporting in line with US GAAP. Other standards are also amended relating to borrowing costs, business combinations, financial instruments, and share-based payments. The document outlines the implementation dates and provides high-level details of the changes required by each new or revised standard.
The document provides one-page summaries of responses from 43 state Medicaid Directors and Washington D.C. on the impact of 7 recent Medicaid regulations. For each state, the summaries include estimates of lost federal funds in 2008 and over 5 years for regulations limiting payments to public providers, graduate medical education, outpatient hospital services, provider taxes, coverage of rehabilitative services, payments for school services, and targeted case management. Quotes from each state convey concerns about reduced access to care, loss of providers and services, and increased costs.
The State of Public Finances: A Cross-Country Fiscal MonitorPeter Ho
The global fiscal response to the crisis has been sizable but implementation has been uneven. Among G-20 countries, fiscal deficits are projected to increase by 5.5% of GDP in both 2009 and 2010 due to discretionary stimulus measures, automatic stabilizers, and falling revenues. Tax cuts have been implemented more quickly than spending measures. While a comprehensive assessment is difficult due to limited reporting, signs indicate the pace of stimulus spending has accelerated recently in some countries like the US. Overall, fiscal expansion has helped counter the economic downturn but medium-term fiscal strategies are still lacking in many countries.
How Did Economist Get It So Wrong Paul KrugmanPeter Ho
This document summarizes how mainstream economists failed to predict or prevent the 2008 financial crisis, despite believing they had resolved internal disputes and "solved" the problem of preventing depressions. It argues that economists mistook theoretical, mathematically elegant models of perfect markets for reality, ignoring limitations of human rationality and market imperfections that can cause crashes. It traces how mainstream economics shifted from Keynesian support for government intervention to stabilize economies to a neoclassical faith in free markets, with devastating consequences in the crisis.
Lessons from the Great Depression for Economic Recovery in 2009Peter Ho
This document discusses lessons from the Great Depression that may help guide economic recovery efforts in 2009. It notes that while the current recession is severe, it is less severe than the Great Depression. It outlines parallels between the two events, including their origins in financial crises and asset price declines. The document discusses four key lessons from the 1930s: 1) small fiscal stimulus had limited effects so a large stimulus is needed; 2) monetary policy can help even at low rates by affecting expectations; 3) stimulus should not be withdrawn too soon; and 4) financial stability and real recovery go hand in hand. The goal is to apply these lessons to end the current recession.
Gouvernance web et crise 2.0 : meilleures pratiquesGuillaume Brunet
La gestion quotidienne d’une présence web demande un plan de gouvernance clair et efficace, des politiques précises et des mécaniques de production et de gestion de contenu. Mais comment implanter ces éléments dans une vaste organisation aux paliers multiples? Dans le même ordre d’idée, comment gérer une crise 2.0 de façon efficace dans une telle organisation?
Comment définir et implanter un plan de gouvernance web?
Comment bien se préparer à une crise 2.0?
Comment produire, gérer et diffuser son contenu de façon optimale?
Guillaume Brunet aura l’occasion, lors de cette conférence, de souligner les meilleures pratiques en matière de communications web, de gouvernance et de gestion de crise dans les institutions et organismes publics.
Maximiser votre présence sur les médias sociaux lors d'un évènement.Republik
Dans le cadre du Circuit INDEX Design 2014, Jean-Philippe Shoiry, associé et stratège nouveaux-médias chez Republik livre une présentation qui démontre comment maximiser sa présence sur les médias sociaux lors d'un évènement.
Pour plus de détails, vous pouvez rejoindre Jean-Philippe : jp.shoiry@republik.ca
CASAtelier de méthologie sur l'organisation d'un événement. Contenu réalisé par CASACO et basé sur l'expérience de plus de 300 événements organisés depuis l'ouverture de notre tiers-lieu.
Le contenu web & multiplateformes : stratégies et bonnes pratiquesCatherine BL
À l'ère où les médias numériques dominent tous les secteurs, comment une marque ou une entreprise peut-elle se distinguer de la masse, atteindre son public et créer la fidélité?
Thèse professionnelle "Quel avenir pour les jeux vidéos en 2016?"Clémence Rigaud
Le jeu vidéo prend une part de plus en plus importante dans la culture, le divertissement et l’économie, et cette part devrait être amenée à grandir encore à l’avenir. Cela nous amène à nous poser les questions suivantes : comment les acteurs du marché peuvent ils encore gagner des parts de marchés ? Comment continuer à être créatif? Comment les marques traditionnelles peuvent-elles se greffer sur ce marché ? Et surtout quels sont les futurs leviers technologiques et marketing possibles pour faire grandir le marché en 2016 ?
The document summarizes a study that uses a structural vector autoregressive (SVAR) model to estimate the impact of unconventional monetary policy on macroeconomic variables in the UK. The study focuses on the bank lending channel as a possible transmission mechanism. The results from the baseline SVAR model show that unconventional monetary policy can generate inflation and increase output, but the effects are small and short-lived. However, the results are not robust for output based on sensitivity analysis. The study also does not find strong evidence that the bank lending channel is a significant transmission mechanism for unconventional monetary policy.
The impact of bank specific variables on the non performing loans ratio in th...Alexander Decker
This document analyzes factors that influence non-performing loan (NPL) ratios in the Albanian banking system. It discusses how NPL ratios have grown substantially since the 2008 financial crisis. The study aims to understand how bank-specific variables like capital adequacy, loan levels, loan-to-asset ratios, net interest margins, and returns on equity can explain NPL ratio levels. Regression analysis of quarterly data from 2002-2012 for Albanian banks will test relationships between NPL ratios and these independent variables.
An analysis of the challenges faced by banks in managing credit in zimbabweAlexander Decker
This document analyzes the challenges faced by banks in managing credit in Zimbabwe after the introduction of a multicurrency system in 2009. It discusses how the multicurrency regime has limited the central bank's ability to inject liquidity into banks. The study examines banks' loan-to-deposit ratios and levels of non-performing loans. Through a survey of banks, the study finds that low lending levels and increasing non-performing loans pose credit risks for banks. Statistical analysis supports the hypothesis that higher lending exposes banks to greater risk of non-performing loans. The challenges of credit management in Zimbabwe's unstable economic environment are also discussed.
This document provides background information on a study about the effects of inflation on the profitability of commercial banks in Uganda. It discusses inflation and how it can reduce purchasing power. It also defines key terms like interest rates, lending, and consumer price index. The problem statement indicates that despite financial reforms, commercial bank performance in Uganda has remained poor due to high inflation, interest rates, and exchange rate volatility. The specific objectives are to determine the effects of exchange rates, interest rates, and consumer price index on bank profitability. The significance is that bank management can use the study to understand inflation's impacts and develop strategies to handle its effects.
This document summarizes a dissertation that examines the extent to which government bailouts during the 2008 financial crisis distorted competition in the European banking sector. It begins with an introduction that provides background on the crisis and vast state aid provided to banks. It then outlines the methodology, literature review, theoretical framework, and analysis that will be used to assess if bailed out banks gained competitive advantages through lower funding costs. The dissertation aims to determine if bailouts undermined competition by benefiting some banks over others.
This paper uses a multi region DSGE model with collateral constrained households and residential investment to examine the effectiveness of fiscal policy stimulus measures in a credit crisis. The paper explores alternative scenarios which differ by the type of budgetary measure, its length, the degree of monetary accommodation and the level of international coordination. In particular we provide estimates for New EU Member States where we take into account two aspects. First, debt denomination in foreign currency and second, higher nominal interest rates, which makes it less likely that the Central Bank is restricted by the zero bound and will consequently not accommodate a fiscal stimulus. We also compare our results to other recent results obtained in the literature on fiscal policy which generally do not consider credit constrained households.
Authored by: Jan in't Veld, Werner Roeger, István P. Székely
Published in 2011
Lesson 6 Discussion Forum Discussion assignments will beDioneWang844
Lesson 6 Discussion Forum :
Discussion assignments will be graded based upon the criteria and rubric specified in the Syllabus.
550 Words
For this Discussion Question, complete the following.
1. Review the two articles about bank failures and bank diversification that are found below this. Economic history assures us that the health of the banking industry is directly related to the health of the economy. Moreover, recessions, when combined with banking crisis, will result in longer and deeper recessions versus recessions that do occur with a healthy banking industry.
2. Locate two JOURNAL articles which discuss this topic further. You need to focus on the Abstract, Introduction, Results, and Conclusion. For our purposes, you are not expected to fully understand the Data and Methodology.
3. Summarize these journal articles. Please use your own words. No copy-and-paste. Cite your sources.
Please post (in APA format) your article citation.
Reply to Post 1: 160 words and Reference
Discussion on Bank’s failures and its diversification
Over the last two decades, business cycle volatility has decreased in the US. For example, some analysts claimed that companies handle inventory better today than ever, or that advances in financial systems have helped smooth industry volatility. Some emphasized stronger economic policy. Banking changes were also drastic in this same era, contributing to the restructuring and convergence of massive, global banking institutions in a better-organized structure. The article (Strahan, 2006) points out that some regulatory reform driven by individual countries rendered it possible for banks to preserve their resources and income by gradually diversifying from local downturns. Both low state volatility rates and a decline in partnerships between the local market and the central banking sector is a net influence on the diversification in banks. Considering the less fragile state economies following these intergovernmental financial reforms, there are some signs that financial convergence – while certainly not the only piece of the puzzle – has been less unpredictable.
Another article (Walter, 2005) argues that a long-standing reason for bank collapses during the crisis is a contagion, which contributes to systemic bank failures and the collapse of one bank initially. This indicates why several losses in the crisis period were unintentional, which ensured that the banks remained stable and endured without contagion-induced falls. The response to the contagion was the central government’s deposit policy, bringing an end to defaults. Nevertheless, since the sequence of errors began in the early 1920s, well before contagion was evident, the underlying trigger must be contagion.
Now it seems like the bank sector has undergone a shake-out that was worsened during the crisis by the deteriorating economic conditions. Although the reality that incidents occurred almost syno ...
Analysis of recovery determinants of defaulted mortgages in nigerian lending ...Alexander Decker
This document summarizes a research paper that analyzed the determinants of recovery of defaulted mortgage loans in the Nigerian lending industry. The study used logistic regression analysis on data from 3,197 defaulted mortgages from 1999-2011 at commercial banks and primary mortgage institutions in Nigeria. The results showed that GDP growth, borrower status, borrower default history, year as a borrower, bank relationship, loan supervision, collateral age, and collateral location were positively associated with loan recovery rates. Meanwhile, inflation growth, interest rates, collateral priority, and collateral revaluation were negatively associated with recovery rates. Other factors like loan-to-value ratio, loan size, and loan duration had insignificant but positive effects on recovery possibility.
Macroeconomic factors that affect the quality of lending in albania.Alexander Decker
This document analyzes the relationship between macroeconomic factors and credit quality in the Albanian banking system from 2005 to 2013. It finds that non-performing loan rates increased, influenced by the economic slowdown after 2008 and currency depreciation. Unemployment, lower GDP growth, reduced remittances, and inflation stability negatively impacted borrowers' ability to repay loans. A regression analysis showed credit risk significantly increased when GDP growth declined and interest rates rose. Macroeconomic changes, like deteriorating GDP growth, substantially affected the level of non-performing loans in Albanian banks.
Journal of Banking & Finance 44 (2014) 114–129Contents lists.docxdonnajames55
Journal of Banking & Finance 44 (2014) 114–129
Contents lists available at ScienceDirect
Journal of Banking & Finance
j o u r n a l h o m e p a g e : w w w . e l s e v i e r . c o m / l o c a t e / j b f
Macro-financial determinants of the great financial crisis: Implications
for financial regulation q
http://dx.doi.org/10.1016/j.jbankfin.2014.03.001
0378-4266/� 2014 Elsevier B.V. All rights reserved.
q We would like to thank the Editor, an anonymous referee, Luc Laeven, Ross
Levine, Marco Pagano, Andrea Sironi, Randy Stevenson, Gianfranco Torriero,
Giuseppe Zadra and seminar participants at IFABS Conference and ISTEIN seminar
for helpful comments. This paper’s findings, interpretations, and conclusions are
entirely those of the authors and do not necessarily represent the views of the
World Bank and the Italian Banking Association.
⇑ Corresponding author. Tel.: +39 02 58362725.
E-mail addresses: [email protected] (G. Caprio Jr.), [email protected]
(V. D’Apice), [email protected] (G. Ferri), [email protected]
(G.W. Puopolo).
Gerard Caprio Jr. a, Vincenzo D’Apice b,c, Giovanni Ferri d,e, Giovanni Walter Puopolo f,⇑
a Williams College, United States
b Economic Research Department of Italian Banking Association, Italy
c Istituto Einaudi (IstEin), Italy
d LUMSA University of Rome, Italy
e Center for Relationship Banking & Economics – CERBE, Italy
f Bocconi University, CSEF and P. Baffi Center, Italy
a r t i c l e i n f o
Article history:
Received 15 April 2012
Accepted 4 March 2014
Available online 29 March 2014
JEL classification:
G01
G15
G18
G21
Keywords:
Banking crisis
Government intervention
Regulation
a b s t r a c t
We provide a cross-country and cross-bank analysis of the financial determinants of the Great Financial
Crisis using data on 83 countries from the period 1998 to 2006. First, our cross-country results show that
the probability of suffering the crisis in 2008 was larger for countries having higher levels of credit
deposit ratio whereas it was lower for countries characterized by higher levels of: (i) net interest margin,
(ii) concentration in the banking sector, (iii) restrictions to bank activities, (iv) private monitoring. The
bank-level analysis reinforces these results and shows that the latter factors are also key determinants
across banks, thus explaining the probability of bank crisis. Our findings contribute to extend the analyt-
ical toolkit available for macro and micro-prudential regulation.
� 2014 Elsevier B.V. All rights reserved.
1. Introduction ment (BCBS, 2010a), has focused more on the stability of the finan-
As much as it was known that the Great Depression of the 1930s
was the acid test for any reputable macroeconomic theory, the out-
break of the Great Financial crisis in 2008 has shaken not only
financial institutions, but also long-held beliefs and theories on
how the regulation of the financial system should be structured,
with renewed emphasis on macro-prudential supervision and
reforming micro-pr.
This document summarizes a paper that analyzes whether central banks should modify their interest rate policy rules (like the Taylor rule) to account for credit spreads or credit volumes. The paper uses a New Keynesian economic model modified to include financial frictions like heterogeneous households and credit markets. It finds that adjusting the policy rate in response to changes in credit spreads or volumes can improve outcomes in response to financial disturbances, but such adjustments may not help or could hurt in response to other disturbance types. The paper concludes by discussing the model and outlining the analysis that will be conducted using the model to evaluate modified policy rules.
The aim of this paper is to examine the impact of bank minimum capital requirement on credit supply in Ivory Coast, over the period from 1982 to 2016. To this end, the ARDL method was used to study the nature of the relationship between our explanatory variables and bank credit supply in Ivory Coast. The study indicates some major results. The results showed that in the short term, real GDP per capita and bank size influence credit supply in Ivory Coast. Real GDP per capita acts negatively on credit supply in the short run while bank size has a positive influence on banks’ capacity to finance the economy. In the long run, the Cooke ratio and the openness rate have an impact on bank credit supply in Ivory Coast. The recovery of bank minimum capital requirements positively influences bank credit supply while the openness of the economy negatively impacts banks’ ability to offer bank credit. In terms of economic policies implications, monetary authorities must enforce and respect the policy of increasing bank minimum capital requirements. They must encourage banks to increase their banking assets.
Estimation of Net Interest Margin Determinants of the Deposit Banks in Turkey...inventionjournals
Banks, which are the irreplaceable intermediaries of the financial system, are financial institutions that significantly contributeto economic development. The basiccriterion that indicates the efficiency of the intermediation activities of banks is the net interest margins. These costs are assumed to be high for developing countries such as Turkey. The degree to which banks are willing to redeem the funds they collect as credit to the system is directly related to how low their intermediation costs will be. In this paper, it is aimed to estimate the net interest margin determinants of deposit banks in Turkey. Three different panel data models are used for this purpose. These are the Fixed and Random Static models and the GMM (Generalized Moment Models) Dynamic model
The aim of this study is to undertake an up-to-date assessment of market power in Central and Eastern European banking markets and explore how the global financial crisis has affected market power and what has been the impact of foreign ownership. Three main results emerge. First, while there is some convergence in country-level market power during the pre-crisis period, the onset of the global crisis has put an end to this process. Second, bank-level market power appears to vary significantly with respect to ownership characteristics. Third, asset quality and capitalization affect differently the margins in the pre-crisis and crisis periods. While in the pre-crisis period the impacts are similar for all banks regardless of ownership status, in the crisis period non-performing loans have a negative effect and capitalization a positive effect only for domestically-owned banks.
Authored by: Georgios Efthyvoulou, Canan Yildirim
Published in 2013
The aim of this paper is to analyze the liquidity levels of various banks in the UAE for the period 2005-2009. To understand the behavior of liquidity indicators especially during the financial crisis, the researcher will analyze the four liquidity indicators over the years 2005 to 2009. The findings highlight how the banks in question have been impacted by the 2007-2008 crisis. This can most obviously be seen in the notable decline of each of the banks liquidity level in 2009. The effect of loans to total assets, loans to customers’ deposit, and investment to total assets ratios for the five banks was most notable in 2009. Two liquidity ratios were analyzed in order to determine the banks’ ability to honor its debt obligations, these being loans to total assets and loans to customers respectively. The third ratio was the total equity to total assets to assess the liquidity level in the capital structure, while the fourth ratio was the investment to total assets to measure the managing of liquidity. While Bank liquidity was affected by the crisis, bank performance remained relatively stable, as measured by coefficient of variation, since these banks were able to yield more control over cash flows in comparison to revenues and costs.
This document introduces an updated database on financial institutions and markets across countries over time. Some key findings:
1) Financial systems have deepened globally in recent decades, but progress has been uneven, concentrated in high-income countries. Markets have deepened more than banks.
2) Banking systems have become larger and more efficient in high-income countries, with declining stability leading up to the 2007 crisis.
3) Financial integration has increased via cross-border lending and bonds, though low/middle-income countries have seen more remittance flows than lending.
Inferences from Interest Rate Behavior for Monetary Policy SignalingIOSR Journals
Weak mean reversion of interest rates towards the long term mean suggests high probability of agents in financial markets failing to interpret monetary policy signalling efficiently and financial market related interest rate unable to achieve equilibrium. Increased randomness penetrating interest rate markets is due to the weak monetary policy signalling effect which dilutes information flow from central banks’ to agents in the financial market. In such cases the effectiveness monetary policy erodes as it departs from the objectives of central banks and financial regulators
This document introduces a new dataset on small and medium enterprises (SMEs) to fill gaps in cross-country SME data. The summary analyzes the dataset and finds:
1) Global SME lending is estimated to be $10 trillion, with 70% in high-income countries.
2) SME loans average 13% of GDP in developed countries and 3% in developing countries.
3) Differences in SME definitions across countries do not significantly impact cross-country comparisons of SME lending volumes.
This document summarizes a new dataset on small and medium enterprise (SME) lending across countries. It finds that many regulators collect SME financing data, though definitions vary. The estimated global SME lending volume is $10 trillion, with 70% in high-income countries. SME loans average 13% of GDP in developed countries and 3% in developing countries. While definitions differ, these differences do not significantly impact reported SME lending volumes.
The global economy is stabilizing after an unprecedented recession, helped by unprecedented policy support. However, the recession is not over and the recovery is expected to be sluggish. While growth is projected to be higher in 2010 than previously expected, the advanced economies are not expected to show sustained growth until the second half of 2010. Financial conditions have improved due to government intervention, but financial systems remain impaired and government support will gradually diminish.
1) The US recovery in the 1930s was rapid until 1937, when unemployment surged again due to a switch to contractionary fiscal and monetary policy that prolonged the Depression.
2) In 1937, fiscal stimulus from veterans bonuses and Social Security taxes disappeared, reducing the deficit by 2.5% of GDP. Additionally, the Federal Reserve doubled bank reserve requirements, unintentionally causing banks to reduce lending and precipitating recession.
3) The author argues that policymakers today must learn from 1937 and resist prematurely withdrawing stimulus until the economy reaches full employment to avoid derailing the recovery.
This document provides a summary of findings from a report by the Committee on Oversight and Government Reform regarding the potential impacts of 7 Medicaid regulations proposed by CMS. Key findings include:
1) State estimates found the regulations could reduce federal Medicaid payments to states by $49.7 billion over 5 years, more than 3 times CMS's estimate of $15 billion.
2) The regulations are likely to shift costs from the federal government to states rather than improve efficiencies.
3) The regulations could disrupt care systems for vulnerable groups and threaten the stability of safety net hospitals and clinics treating uninsured patients.
4) The regulations would impose significant administrative burdens and costs on state Medicaid programs.
5
This document summarizes the 2009 Medicare & You handbook. It provides information about Medicare coverage, costs, and options. Key points include:
- Medicare covers hospital insurance (Part A), medical insurance (Part B), Medicare Advantage plans (Part C), and prescription drug coverage (Part D).
- Coverage and costs vary depending on the plan. Part A has a deductible and Part B has a premium and deductible. Advantage plans have premiums, deductibles, and other costs.
- Individuals have choices in how they receive Medicare benefits, including Original Medicare or Medicare Advantage plans. Plans must be joined during specific enrollment periods.
- The handbook provides information to help
The document provides an overview and outlook of the global economy in the aftermath of the global financial crisis. It discusses how the crisis has led to a sharp decline in global growth, private capital flows, commodity prices, and industrial production. It also examines the policy responses of countries and risks to recovery. Key challenges going forward include strengthening confidence, coordinating policies, and mitigating the crisis's impact on low-income countries. The outlook remains uncertain with downside risks including weak medium-term growth and the potential for balance of payments crises in countries with large financing needs.
The document is a summary of the World Economic Outlook report from April 2009 published by the IMF. It discusses the state of the global economy during the financial crisis. The key points are:
1) The global economy contracted by 1.3% in 2009, the deepest post-World War II recession, with output declining in three-quarters of the global economy. Growth was projected to pick up to 1.9% in 2010 but remain sluggish.
2) Financial market stabilization was expected to take longer than previously thought, keeping financial conditions weak and reducing credit to the private sector in advanced economies in 2009-2010. Total global write-downs on assets could reach $4 trillion over two years.
This document presents an estimated arbitrage-free model that jointly models nominal and real US Treasury yields. It estimates separate arbitrage-free Nelson-Siegel models for nominal and real yields, finding a three-factor model fits nominal yields well and a two-factor model fits real yields. It then estimates a four-factor joint model that fits both yield curves. The joint model is used to decompose breakeven inflation rates into inflation expectations and inflation risk premium components.
This document summarizes a study that estimates a dynamic stochastic general equilibrium (DSGE) model to quantify the role of financial frictions, known as the financial accelerator mechanism, in U.S. business cycle fluctuations from 1973 to 2008. The model incorporates a high-information content credit spread index to identify the financial accelerator parameters and measure the impact of financial shocks on the real economy. Estimation results identify an operative financial accelerator, where increases in external financing costs significantly reduce investment and output. Financial disturbances accounted for significant portions of investment and output declines during economic downturns, particularly in the 1970s.
This paper integrates agency costs into a standard Dynamic New Keynesian model in a transparent way. Agency costs are modeled as a collateral constraint on entrepreneurial hiring of labor based on net worth. Three key results are:
1) Agency costs act as endogenous markup shocks in the Phillips curve.
2) The model welfare function includes a measure of credit market tightness interpreted as a risk premium.
3) Optimal monetary policy can be characterized as an inflation targeting rule, but it may optimally deviate from strict inflation stabilization in response to financial shocks.
The Size of the Fiscal Expansion: An Analysis for the Largest CountriesPeter Ho
The document analyzes the size of fiscal stimulus packages implemented by major countries in response to the 2008 financial crisis. It finds that the size of packages varied significantly, ranging from 4.8% of GDP for the US to 0.5% for India. This variation is explained by differences in the need for stimulus due to factors like automatic stabilizers and output gaps, as well as differences in available fiscal space constrained by public debt levels and financial sector support needs. While stimulus efforts will provide important support to growth, the outlook remains weak and downside risks remain, so some argue additional fiscal action may be needed if properly designed to not permanently increase deficits.
A Non-Random Walk Revisited: Short- and Long-Term Memory in Asset PricesPeter Ho
This paper examines the possibility of short- and long-term memory in international asset prices across 44 markets. Using random walk tests over multiple lags, the authors find mixed evidence of long memory, with some emerging markets and commodity/currency markets exhibiting long memory properties. Regression of a dummy variable indicates that markets with poorer risk-adjusted returns are more likely to reject the random walk hypothesis. Additionally, the choice of truncation lag in long memory tests is found to have little bearing on the results.
Non-Performing Loans, Prospective Bailouts, and Japan’s SlowdownPeter Ho
This document discusses Japan's prolonged economic slowdown since the early 1990s and argues that the government's delay in bailing out financial institutions burdened with non-performing loans (bad loans) played a key role. The author constructs an economic model showing how bad loans combined with delayed bailout can lead to a persistent decline in economic activity by reducing bank lending. Quantitative analysis estimates the delayed bailout may have reduced Japan's annual GDP growth by up to 0.92 percentage points, accounting for much of its slow growth.
Why the U.S. Treasury Began Auctioning Treasury Bill in 1929Peter Ho
In 1929, the U.S. Treasury introduced Treasury bills to address flaws in its financing operations from the 1920s. Specifically, Treasury debt offerings were chronically oversubscribed when sold at fixed prices, and the Treasury had to borrow in advance of its needs between its quarterly debt sales and tax payment dates. By auctioning Treasury bills regularly and on an as-needed basis, the Treasury was able to better manage its cash flows and meet its financing needs in a more flexible manner. The introduction of Treasury bills allowed the Treasury to mitigate defects in the existing system while maintaining the overall structure of its operations.
The document summarizes Martin Wolf's lecture on the failures of global finance and capital flows that have led to emerging market crises. Some key points:
1. Financial liberalization in emerging markets led to excessive risk-taking and poor regulation, fueling credit growth and asset bubbles.
2. Macroeconomic imbalances like fiscal deficits and currency pegs exacerbated risks. Currency crises then triggered financial crises as foreign debt overwhelmed many countries and companies.
3. Major crises included the Latin American debt crisis in the 1980s, the Mexican "Tequila" crisis of 1994-95, the Asian Financial crisis of 1997-98, and the Argentine crisis of 2001-02. The Asian crisis
O documento é uma entrevista com o psiquiatra Roberto Shinyashiki onde ele discute sobre heróis de verdade e a supervalorização das aparências na sociedade. Ele argumenta que falta competência ao Brasil e não autoestima, e que heróis de verdade são aqueles que trabalham para realizar seus projetos de vida em vez de impressionar os outros. Ele também critica o mundo corporativo por valorizar mais a autoestima do que a competência.
1. Elemental Economics - Introduction to mining.pdfNeal Brewster
After this first you should: Understand the nature of mining; have an awareness of the industry’s boundaries, corporate structure and size; appreciation the complex motivations and objectives of the industries’ various participants; know how mineral reserves are defined and estimated, and how they evolve over time.
[4:55 p.m.] Bryan Oates
OJPs are becoming a critical resource for policy-makers and researchers who study the labour market. LMIC continues to work with Vicinity Jobs’ data on OJPs, which can be explored in our Canadian Job Trends Dashboard. Valuable insights have been gained through our analysis of OJP data, including LMIC research lead
Suzanne Spiteri’s recent report on improving the quality and accessibility of job postings to reduce employment barriers for neurodivergent people.
Decoding job postings: Improving accessibility for neurodivergent job seekers
Improving the quality and accessibility of job postings is one way to reduce employment barriers for neurodivergent people.
How Does CRISIL Evaluate Lenders in India for Credit RatingsShaheen Kumar
CRISIL evaluates lenders in India by analyzing financial performance, loan portfolio quality, risk management practices, capital adequacy, market position, and adherence to regulatory requirements. This comprehensive assessment ensures a thorough evaluation of creditworthiness and financial strength. Each criterion is meticulously examined to provide credible and reliable ratings.
OJP data from firms like Vicinity Jobs have emerged as a complement to traditional sources of labour demand data, such as the Job Vacancy and Wages Survey (JVWS). Ibrahim Abuallail, PhD Candidate, University of Ottawa, presented research relating to bias in OJPs and a proposed approach to effectively adjust OJP data to complement existing official data (such as from the JVWS) and improve the measurement of labour demand.
Lecture slide titled Fraud Risk Mitigation, Webinar Lecture Delivered at the Society for West African Internal Audit Practitioners (SWAIAP) on Wednesday, November 8, 2023.
Understanding how timely GST payments influence a lender's decision to approve loans, this topic explores the correlation between GST compliance and creditworthiness. It highlights how consistent GST payments can enhance a business's financial credibility, potentially leading to higher chances of loan approval.
5 Tips for Creating Standard Financial ReportsEasyReports
Well-crafted financial reports serve as vital tools for decision-making and transparency within an organization. By following the undermentioned tips, you can create standardized financial reports that effectively communicate your company's financial health and performance to stakeholders.
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1. Credit and Banking in a DSGE Model
of the Euro Area
Andrea Gerali Stefano Neri Luca Sessa Federico M. Signoretti∗
May 11, 2009
Abstract
This paper studies the role of credit-supply factors in business cycle fluctuations. To
this end, an imperfectly competitive banking sector is introduced into a DGSE model
with financial frictions. Banks issue loans to both households and firms, obtain
funding via deposits and accumulate capital out of retained earnings. Margins
charged on loans depend on bank capital-to-asset ratio and on the degree of interest
rate stickiness. Bank balance-sheet constraints establish a link between the business
cycle, which affects bank profits and thus capital, and the supply and the cost of
loans. The model is estimated with Bayesian techniques using data for the euro
area. We show that shocks originating in the banking sector explain the largest
fraction of the fall of output in 2008 in the euro area, while macroeconomic shocks
played a smaller role. We also find that an unexpected reduction in bank capital can
have a substantial impact on the real economy and particularly on investment.
JEL: E30; E32; E43; E51; E52;
Keywords: Collateral Constraints; Banks; Banking Capital; Sticky Interest Rates.
∗
Banca d’Italia, Research Department. The opinions expressed here are those of the authors only
and do not necessarily reflect the view of the Banca d’Italia. Email: andrea.gerali@bancaditalia.it; ste-
fano.neri@bancaditalia.it; luca.sessa@bancaditalia.it; federicomaria.signoretti@bancaditalia.it. We ben-
efited of useful discussions with Tobias Adrian, Vasco C´rdia, Jordi Gal´ Eugenio Gaiotti, Leonardo
u ı,
Gambacorta, Matteo Iacoviello, John Leahy, Jesper Lind´, Fabio Panetta, Anti Ripatti, Argia Sbordone
e
and Mike Woodford. We also thanks participants at the Bank of Italy June ’08 “DSGE in the Policy
Environment” conference, the Macro Modeling Workshop ’08, the WGEM and CCBS July ’08 Workshop
at the Bank of England, the “Financial Markets and Monetary Policy” December ’08 conference at the
European Central Bank and at the NY Federal Reserve seminar series.
2. 1 Introduction
Policymakers have often highlighted the importance of financial factors in shaping the
business cycle: the possible interactions between credit markets and the real economy are
a customary part of the overall assessment on the policy stance. Since the onset of the
financial turmoil in August 2007, banks have come again under the spotlight, as losses from
subprime credit exposure and from significant write-offs on asset-backed securities raised
concerns that a wave of widespread credit restrictions might trigger a severe economic
downturn. Credit standard for firms and households were tightened considerably both
in the US and the euro area (Figure 1) as suggested by the Senior Loan Officer Survey
of the Federal Reserve and the Bank Lending Survey of the Eurosystem. Past episodes
like the U.S. Great Depression, the Savings and Loans crises again in the U.S. in the
1980s or the prolonged recession in Finland and Japan in the 1990s stand as compelling
empirical evidence that the banking sector can considerably affect the developments of
the real economy.1
Despite this relevance for policy-making, most workhorse general equilibrium models
routinely employed in academia and policy institutions to study the dynamics of the
main macroeconomic variables generally lack any interaction between financial and credit
markets, on the one hand, and the rest of the economy, on the other. The introduction
of financial frictions in a dynamic general equilibrium (DSGE) framework by Bernanke,
Gertler and Gilchrist (1999) and Iacoviello (2005) has started to fill this gap by intro-
ducing credit and collateral requirements and by studying how macroeconomic shocks
are transmitted or amplified in the presence of these financial elements. These models
assume that credit transactions take place through the market and do not assign any role
to financial intermediaries such as banks.
But in reality banks play a very influential role in modern financial systems, and
especially in the euro area. In 2006, bank deposits in the euro area accounted for more
than three-quarters of household short-term financial wealth, while loans equaled around
90 per cent of total households liabilities (ECB, 2008); similarly, for firms, bank lending
accounted for almost 90 per cent of total corporate debt liabilities in 2005 (ECB, 2007).
Thus, the effective cost/return that private agents in the euro area face when taking their
borrowing/saving decisions are well approximated by the level of banks’ interest rates on
loans and deposits.
1
Awareness seemed to be widespread among economists and policy-makers well before the financial
turmoil burst out. For example, in a speech at the “The Credit Channel of Monetary Policy in the
Twenty-first Century”Conference held on 15 June 2007 at the Federal Reserve Bank of Atlanta, chairman
Bernanke stated that “...Just as a healthy financial system promotes growth, adverse financial conditions
may prevent an economy from reaching its potential. A weak banking system grappling with nonperforming
loans and insufficient capital, or firms whose creditworthiness has eroded because of high leverage or
declining asset values, are examples of financial conditions that could undermine growth”.
2
3. In this paper we introduce a banking sector in a DSGE model in order to understand
the role of banking intermediation in the transmission of monetary impulses and to ana-
lyze how shocks that originate in credit markets are transmitted to the real economy. We
are not the first to do this. Recently there has been increasing interest in introducing a
banking sector in dynamic models and to analyze economies where a plurality of financial
assets, differing in their returns, are available to agents (Christiano et al., 2007, and Good-
friend and McCallum, 2007). But in these cases banks operate under perfect competition
and do not set interest rates. We think that a crucial element in modeling banks sector
consists in recognizing them a degree of monopolistic power (in both the deposits and the
loans markets). This allows us to model their interest rate setting behavior and hence also
the different speeds at which banks interest rates adjust to changing conditions in money
market interest rates. Empirical evidence shows that bank rates are indeed heterogeneous
in this respect, with deposit rates adjusting somewhat slower than rates on households
loans, and those in turn slower than rates on firms loans (Kok Sorensen and Werner, 2006
and de Bondt, 2005). On the other hand, compliance to Basel Accords imposes capital
requirements to exert banking activity. We therefore enrich a standard model, featuring
credit frictions and borrowing constraints as in Iacoviello (2005), and a set of real and
nominal frictions as in Christiano et al. (2005) and Smets and Wouters (2003) with an
imperfectly competitive banking sector that collects deposits and then, subject to the
requirement of using banking capital as an input, supplies loans to the private sector.
These banks set different rates for households and firms, applying a time-varying and
slowly adjusting mark-up over the marginal cost of loan production, which includes the
interbank rate and the cost of equity. Loan demand is constrained by the value of housing
collateral for households and capital for entrepreneurs. Banks obtain funding either by
tapping the interbank market at a rate set by the monetary authority or by collecting
deposits from patient households, at a rate set by the banks themselves with a mark-down
over the interbank rate.
We estimate the model with Bayesian techniques and data for the euro area over the
period 1999-2008. The model is used to understand the role of banks and imperfect
competition in the banking sector in the transmission mechanism of monetary policy and
technology shocks. We use it to quantify the contribution of shocks originating within
the banking sector to the slowdown in economic activity during 2008 and to study the
consequences of tightening of credit conditions induced by a reduction in bank capital.
The analysis delivers the following results. First, while financial frictions amplify the
effects of monetary policy compared to a standard new keynesian model, sticky bank rates
dampen (attenuator effect) the effects on the economy that work through a change in the
real rate or in the value of the collateral. Second, shocks in the banking sector explain the
largest fraction of the fall output in 2008 in the euro area while macroeconomic shocks
played a smaller role. Finally, shocks to credit supply can have substantial effects on
3
4. the economy and particularly on investment. A fall in bank capital forces bank to raise
interest rates resulting in lower demand for loans by households and firms who are forced
to cut on consumption and expenditure.
The rest of the paper is organized as follows. Section 2 describes the model. Section
3 presents the results of the estimation of the model. Section 4 studies the dynamic
properties of the model focusing on monetary policy and technology shocks. Section 5
quantifies the role of shocks originating in the banking sector in the downturn in economic
activity in the euro area during 2008 and studies the effects of a fall in bank capital on
the economy. Section 6 offers some concluding remarks.
2 The model
The economy is populated by two types of households and by entrepreneurs. Households
consume, work and accumulate housing (in fixed supply), while entrepreneurs produce
an homogenous intermediate good using capital bought from capital-good producers and
labor supplied by households. Agents differ in their degree of impatience, i.e. in the
discount factor they apply to the stream of future utility.
Two types of one-period financial instruments, supplied by banks, are available to
agents: saving assets (deposits) and loans. When taking on a bank loan, agents face
a borrowing constraint, tied to the value of tomorrow collateral holdings: households
can borrow against their stock of housing, while entrepreneurs’ borrowing capacity is
tied to the value of their physical capital. The heterogeneity in agents’ discount factors
determines positive financial flows in equilibrium: patient households purchase a posi-
tive amount of deposits and do not borrow, while impatient and entrepreneurs borrow a
positive amount of loans. The banking sector operates in a regime of monopolistic com-
petition: banks set interest rates on deposits and on loans in order to maximize profits.
The amount of loans issued by each intermediary can be financed through the amount of
deposits that they rise and through reinvested profits (bank capital).
Workers supply their differentiated labor services through unions which set wages to
maximize members’ utility subject to adjustment costs: services are sold to a competitive
labor packer which supplies a single labor input to firms.
Two additional producing sectors exist: a monopolistically competitive retail sector and
a capital-good producing sector. Retailers buy the intermediate goods from entrepreneurs
in a competitive market, brand them at no cost and sell the final differentiated good
at a price which includes a markup over the purchasing cost and is subject to further
adjustment costs. Physical capital good producers are used as a modeling device to
derive an explicit expression for the price of capital, which enters entrepreneurs’ borrowing
constraint.
4
5. 2.1 Households and entrepreneurs
There exist two groups of households, patients and impatiens, and entrepreneurs. Each
of these group has unit mass. The only difference between these agents is that patients’
discount factor (βP ) is higher than impatients’ (βI ) and entrepreneurs (βE ).
2.1.1 Patient households
The representative patient household maximizes the expected utility:
∞
lt (i)1+φ
P
E0 βP εz log(cP (i) − aP cP ) + εh log hP (i) −
t
t t t−1 t t
t=0
1+φ
which depends on current individual consumption cP (i), lagged aggregate consumption
t
cP , housing services hP (i) and hours worked lP (i). The parameter aP measures the de-
t−1
gree of (external and group-specific) habit formation in consumption; εh captures exoge-
t
nous shocks to the demand for housing while εz is an intertemporal shock to preferences.
t
These shocks have an AR(1) representation with i.i.d normal innovations. The autore-
gressive coefficients are, respectively, ρz and ρj and the standard deviations are σz and
σj . Household decisions have to match the following budget constraint (in real terms):
d
1 + rt−1 P
cP (i)
t + qt ∆hP (i)
h
t + dP (i)+
t ≤ WtP lt (i)
P
+ dt−1 (i) + TtP
πt
The flow of expenses includes current consumption, accumulation of housing services and
deposits to be made this period dP . Resources are composed of wage earnings WtP lt ,
t
P
(1+rt−1 ) P
d
gross interest income on last period deposits πt
dt−1 (the inflation rate πt is gross,
i.e. it is defined as Pt /Pt−1 ) and a number of lump-sum transfers TtP , which include
the labor union membership net fee, dividends from the retail firms JtR and the banking
b
Jt−1
sector dividends 1 − ω b πt
.
2.1.2 Impatient households
Impatient households do not hold deposits and do not own retail firms but receive divi-
dends from labor unions. The representative impatient household maximizes the expected
utility:
∞
t z I I I h I lt (i)1+φ
I
E0 βI εt log(ct (i) − a ct−1 ) + εt log ht (i) −
t=0
1+φ
which depends on consumption cI (i), housing services hI (i) and hours worked lI (i). The
parameter aI measures the degree of (external and group-specific) habit formation in
5
6. consumption; εh and εz are the same shocks that affect the utility of patient households.
t t
Household decisions have to match the following budget constraint (in real terms):
bH
1 + rt−1 I
cI (i) + qt ∆hI (i) +
t
h
t bt−1 ≤ WtI lt(i) + bI (i) + TtI
I
t
πt
in which resources spent for consumption, accumulation of housing services and reim-
boursement of past borrowing have to be financed with the wage income and new bor-
rowing (TtI only includes net union fees to be paid).
In addition, households face a borrowing constraint: the expected value of their col-
lateralizable housing stock at period t must be sufficient to guarantee lenders of debt
repayment. The constraint is:
1 + rt bI (i) ≤ mI Et qt+1 hI (i)πt+1
bH
t t
h
t (1)
where mI is the (stochastic) loan-to-value ratio (LTV) for mortgages. From a microe-
t
conomic point of view, (1-mI ) can be interpreted as the proportional cost of collateral
t
repossession for banks given default. Our assumption on households’ discount factors is
such that, absent uncertainty, the borrowing constraint of the impatien is binding in a
neighborhood of the steady state. As in Iacoviello (2005), we assume that the size of
shocks in the model is “small enough” so to remain in such a neighborhood, and we can
thus solve our model imposing that the borrowing constraint always binds.
We assume that the LTV follows the stochastic AR(1) process
mI = (1 − ρmI ) mI + ρmI mI + ηt
t ¯ t−1
mI
mI
where ηt is an i.i.d. zero mean normal random variable with standard deviation equal
to σmI and mI is the (calibrated) steady-state value. We introduce a stochastic LTV
¯
because we are interested in studying the effects of credit-supply restrictions on the real
side of the economy. At a macro-level, the value of mI determines the amount of credit
t
that banks make available to each type of households, for a given (discounted) value of
their housing stock.
2.1.3 Entrepreneurs
In the economy there is an infinity of entrepreneurs of unit mass. Each entrepreneur i
only cares about his own consumption cE (i) and maximizes the following utility function:
∞
E0 βE log(cE (i) − aE cE )
t
t t−1
t=0
where aE , symmetrically with respect to households, measures the degree of consumption
habits. Entrepreneurs’ discount factor βE is assumed to be strictly lower than βP , imply-
ing that entrepreneurs are, in equilibrium, net borrowers. In order to maximize lifetime
6
7. E
consumption, entrepreneurs choose the optimal stock of physical capital kt (i), the de-
gree of capacity utilization ut (i), the desired amount of labor input lE (i) and borrowing
bE (i). Labor and effective capital are combined to produce an intermediate output yt (i)
t
E
according to the production function
yt (i) = aE [kt−1 (i)ut (i)]α lt (i)1−α
E
t
E E
where aE is an exogenous AR(1) process for total factor productivity with autoregressive
t
a
coefficient equal to ρa and i.i.d. normal innovations ηt with standard deviation equal to
σa . Labour of the two households are combined in the production function in a Cobb-
Douglas fashion as in Iacoviello and Neri (2008). The parameter µ measures the labor
income share of unconstrained households.
The intermediate product is sold in a competitive market at wholesale price Ptw . En-
trepreneurs have access to loan contracts (bE (i), in real terms) offered by banks, which
t
they use to implement their borrowing decisions. Entrepreneurs’ flow budget constraint
in real terms is thus the following:
(1 + rt−1 )bE (i)
bE
t−1
cE(i) + Wt lt (i) +
t
E k E E
+ qt kt (i) + ψ(ut (i))kt−1(i)
πt
y E (i)
= t + bE (i) + qt (1 − δ)kt−1(i).
t
k E
(2)
xt
k
In the above, Wt is the aggregate wage index, qt is the price of one unit of physical
E
capital in terms of consumption; ψ(ut (i))kt−1 (i) is the real cost of setting a level ut (i) of
utilization rate, with ψ(ut ) = ξ1 (ut − 1) + ξ22 (ut − 1)2 (following Schmitt-Grohe and Uribe,
2005); 1/xt is the price in terms of the consumption good of the wholesale good produced
by each entrepreneur, i.e. xt is defined as Pt /PtW .
Symmetrically with respect to households, we assume that the amount of resources that
banks are willing to lend to entrepreneurs is constrained by the value of their collateral,
which is given by their holdings of physical capital. This assumption differs from Iacoviello
(2005), where also entrepreneurs borrow against housing (interpretable as commercial real
estate), but it seems a more realistic modeling choice, as overall balance-sheet conditions
give the soundness and creditworthiness of a firm. The borrowing constraint is thus
(1 + rt )bE (i) ≤ mE Et (qt+1 πt+1 (1 − δ)kt (i))
bE
t t
k E
(3)
where mE is the entrepreneurs’ loan-to-value ratio; similarly to households, mE follows
t t
the stochastic process
t ¯ t−1
mE
mE = (1 − ρmE ) mE + ρmE mE + ηt
mE
with ηt being a zero mean normal random i.i.d. variable with standard deviation equal
to σmE . The assumption on the discount factor βE and of “small uncertainty” allows us to
solve the model by imposing an always binding borrowing constraint for the entrepreneurs.
7
8. The presence of the borrowing constraint implies that the amount of capital that en-
trepreneurs will be able to accumulate each period is a multiple of their net worth.2 In
particular, capital is inversely proportional to the down payment that banks require in
order to make one unit of loans, which is in turn a function of the LTV ratio, of the ex-
pected future price of capital and of the real interest rate on loans. It is this feature that
gives rise - in a model with a borrowing constraint - to a financial accelerator, whereby
changes in interest rates or asset prices modify the transmission of shocks, amplifying -
for instance - monetary policy shocks.
2.1.4 Loan and deposit demand
We assume that units of deposit and loan contracts bought by households and en-
trepreneurs are a composite CES basket of slightly differentiated products -each supplied
by a branch of a bank j- with elasticities of substitution equal to εd , εbH and εbE , re-
t t t
spectively. As in the standard Dixit-Stiglitz framework for goods markets, in our credit
market agents have to purchase deposit (loan) contracts from each single bank in order to
save (borrow) one unit of resources. Although this assumption might seem unrealistic, it
is just a useful modeling device to capture the existence of market power in the banking
industry.3
We assume that the elasticity of substitution in the banking industry is stochastic.
This choice arises from our interest in studying how exogenous shocks hitting the banking
sector transmit to the real economy. εbH and εbE (εd ) affect the value of the markups
t t t
(markdowns) that banks charge when setting interest rates and, thus, the value of the
spreads between the policy rate and the retail loan (deposit) rates. Innovations to the
loan (deposit) markup (markdown) can thus be interpreted as innovations to bank spreads
arising independently of monetary policy and we can analyze their effects on the real
economy.
Given the Dixit-Stiglitz framework, demand for an individual bank’s loans and deposits
depends on the interest rates charged by the bank - relative to the average rates in the
economy. The demand function for household i seeking an amount of borrowing equal to
bH (i) can be derived from minimizing the due total repayment:
t
1
min rt (j)bI (i, j)dj
bH
t
{ }
bH (i,j)
t 0
2
The same reasoning applies to the accumulation of housing by impatient households.
3
A similar shortcut is taken by Benes and Lees (2007). Arce and Andr´s (2008) set up a general
e
equilibrium model featuring a finite number of imperfectly competitive banks in which the cost of banking
services is increasing in customers’ distance.
8
9. subject to
εbH
t
1 εbH −1
t
bH −1
εt
bH (i, j)
t
εbH
t dj ≥ bI (i) .
t
0
Aggregating f.o.c.’s across all impatient households, aggregate impatient households’ de-
mand for loans at bank j is obtained as:
bH −εbH
rt (j) t
bH (j)
t = bH
bI
t
rt
where bI ≡ γ I bI (i) indicates aggregate demand for household loans in real terms (γ s ,
t t
bH
s ∈ [P, I, E] indicates the measure of each subset of agents) and rt is the average
interest rates on loans to households, defined as:
1
1 1−εbH
bH bH 1−εbH t
rt = rt (j) t dj .
0
Demand for entrepreneurs’ loans is obtained analogously, while demand for deposits
at bank j of impatient household i, seeking an overall amount of (real) savings dP (i), is
t
obtained by maximizing the revenue of total savings
1
max rt (j)dP (i, j)dj
d
t
{
dP (i,j)
t } 0
subject to the aggregation technology
εdt
1 εd −1
t εd −1
t
dP (i, j)
t
εdt dj ≥ dtP (i)
0
and is given by (aggregating across households):
d −εd
rt (j) t
dP (j)
t = d
dt (4)
rt
where dt ≡ γ P dP (i) and rt is the aggregate (average) deposit rate, defined as
t
d
1
1 1−εd
d d t
rt = rt (j)1−εt
d
dj .
0
2.1.5 Labor market
We assume that there exists a continuum of labor types and two unions for each labor type
n, one for patients and one for impatients. Each union sets nominal wages for workers
9
10. of its labor type by maximizing a weighted average of its members’ utility, subject to a
constant elasticity ( l ) demand schedule and to quadratic adjustment costs (premultiplied
t
by a coefficient κw ), with indexation ιw to a weighted average of lagged and steady-state
inflation. Each union equally charges each member household with lump-sum fees to cover
adjustment costs. In a symmetric equilibrium, the labor choice for each single household
in the economy will be given by the ensuing (non-linear) wage-Phillips curve. We also
assume the existence of perfectly competitive “labor packers” who buy the differentiated
labor services from unions, transform them into an homogeneous composite labor input
and sell it, in turn, to intermediate-good-producing firms. These assumptions yield a
demand for each kind of differentiated labor service lt (n) equal to
−εl
Wt (n) t
lt (n) = lt (5)
Wt
where Wt is the aggregate wage in the economy. The stochastic elasticity of labour demand
l
implies a time-varying AR(1) markup process with innovations ηt normally distributed
with zero mean and standard deviation equal to σl .
In the adjustment cost function for nominal wages, the parameter denotes the param-
eters measuring the size of these costs, while measures the degree of indexation to past
prices.
2.2 Banks
The banks play a central role in our model since they intermediate all financial transactions
between agents in the model. The only saving instrument available to patient households
is bank deposits, the only way to borrow, for impatient households and entrepreneurs, is
by applying for a bank loan.
The first key ingredient in how we model banks is the introduction of monopolistic
competition at the banking retail level. Banks enjoy some market power in conducting
their intermediation activity, which allows them to adjust rates on loans and rates on de-
posits in response to shocks or other cyclical conditions in the economy. The monopolistic
competition setup allows us to study how different degrees of interest rate pass-through
affect the transmission of shocks, in particular monetary policy.
The second key feature of our banks is that they have to obey a balance sheet identity
Bt = Dt + Ktb
stating that banks can finance their loans Bt using either deposits Dt or bank equity
(also called bank capital in the following) Ktb .4 The two sources of finance are perfect
4
When taking the model to the data we introduce a shock εb into the balance sheet condition.
t
b
This shock has an AR(1) representation with autoregressive coefficient ρb and innovations ηt which are
normally distributed with zero mean and variance equal to σb .
10
11. substitutes from the point of view of the balance sheet, and we need to introduce some
non-linearity (i.e. imperfect substitutability) in order to pin down the choices of the
bank. We assume that there exists an (exogenously given) “optimal” capital-to-assets
(i.e. leverage) ratio for banks, which can be thought of as capturing the trade-offs that, in
a more structural model, would arise in the decision of how much own resources to hold,
or alternatively as a shortcut for studying the implications and costs of regulatory capital
requirements. Given this assumption, bank capital will have a key role in determining
the conditions of credit supply, both for quantities and for prices. In addition, since we
assume that bank capital is accumulated out of retained earnings, the model has a built-in
feedback loop between the real and the financial side of the economy. As macroeconomic
conditions deteriorate, banks profits are negatively hit, and this weaken the ability of
banks to raise new capital; depending on the nature of the shock that hit the economy,
banks might respond to the ensuing weakening of their financial position (i.e. increased
leverage) by reducing the amount of loans they are willing to give, thus exacerbating
the original contraction. The model can thus potentially account for the type of “credit
cycle” typically observed in recent recession episodes, with a weakening real economy, a
reduction of bank profits, a weakening of banks’ capital position and the ensuing credit
restriction.
The presence of both ingredients, bank capital and the ability of banks to set rates,
allows us to introduce a number of shocks that originate from the supply side of credit and
thus to study their effects and their propagation to the real economy. In particular we
can study the effects of a drastic weakening in the balance sheet position of the banking
sector, or the effect of an exogenous rise in loans rates.
To better highlight the distinctive features of our banking sector and to facilitate ex-
position, we can think of each bank j in the model (j ∈ [0, 1]) as actually composed of
three parts, two “retail” branches and one “wholesale” unit. The two retail branches are
responsible for giving out differentiated loans to entrepreneurs and raising differentiated
deposits from households, respectively. These branches set rates in a monopolistic com-
petitive fashion, subject to adjustment costs. The wholesale unit manages the capital
position of the group and, in addition, raises wholesale loans and wholesale deposits in
the interbank market.
2.2.1 Wholesale branch
The wholesale branch combines net worth, or bank capital (Ktb ), and wholesale deposits
(Dt ) on the liability side and issues wholesale loans (Bt ) on the asset side. We impose a
cost on this wholesale activity related to the capital position of the bank. In particular,
the bank pays a quadratic cost whenever the capital-to-assets ratio (Ktb /Bt ) moves away
from an “optimal” value ν b . This parameter is usually set equal to 0.09 in our numerical
experiments, a level consistent with much of the regulatory capital requirements for banks,
11
12. which in turn tries to strike a balance between various trade-offs involved when deciding
how much own resources a bank should keep.
Bank capital is accumulated each period out of retained earnings according to:
Ktb,n (j) = 1 − δ b Kt−1 (j) + ω b Jt−1 (j)
b,n b,n
where Ktb,n (j) is bank equity of bank j in nominal terms, Jtb,n (j) are overall profits made
by the three branches of bank j in nominal terms, (1−ω b ) summarizes the dividend policy
of the bank, and δ b measures resources used in managing bank capital and conducting
the overall banking intermediation activity.
The dividend policy is assumed to be exogenously fixed, so that bank capital is not
a choice variable for the bank. The problem for wholesale bank is thus to choose loans
Bt (j) and deposits Dt (j) so as to maximize profits, subject to a balance sheet constraint5 :
∞ 2
κKb Ktb (j)
max E0 Λp
0,t 1+ b
Rt Bt (j) − 1 + d
Rt Dt (j) − Ktb (j) − − νb Ktb (j)
t=0
2 Bt (j)
(6)
s.t. Bt (j) = Dt (j) + Ktb (j) , (7)
b d
where Rt - the net wholesale loan rate - and Rt - the net deposit rate - are taken as given.
The first order conditions of the problem deliver a condition linking the spread between
wholesale rates on loans and on deposits to the degree of leverage Bt (j)/Ktb (j) of bank j,
i.e.:
2
b d Ktb (j) Ktb (j)
Rt = Rt − κKb − νb
Bt (j) Bt (j)
In order to close the model we assume that banks can invest any excess fund they have
in a deposit facility at the Central bank remunerated at rate rt (or, alternatively, can
d
purchase any amount of a riskless bond remunerated at that rate), so that Rt ≡ rt in the
interbank market. As the interbank market is populated by many (identical) wholesale
banks, in a symmetric equilibrium the equation above states a condition that links the
b
rate on wholesale loans prevailing in the interbank market Rt to the official rate rt , on
one hand, and to the leverage of the banking sector Bt /Ktb on the other:
2
b Ktb Ktb
Rt = rt − κKb − νb (8)
Bt Bt
The above equation highlights the role of capital in determining loan supply conditions.
On the one hand - as far as there exists a spread between loan and the policy rate - the
bank would like to extend as many loans as possible, increasing leverage and thus profit
5
Banks value the future stream of profits using the patient households discount factor Λp since they
0,t
are owned by patients.
12
13. per unit of capital (or return on equity). On the other hand, when leverage increases, the
capital-to-asset ratio moves away from ν and banks pay a cost, which reduces profits. The
optimal choice for banks (from the first order condition) is to choose a level of loans (and
thus of leverage, given Ktb ) such that the marginal cost for reducing the capital-to-asset
ratio exactly equals the deposit-loan spread. The equation (8) can also be rearranged to
highlight the spread between (wholesale) loan and deposit rates:
2
Ktb Ktb
StW ≡ b
Rt − rt = −κKb − νb (9)
Bt Bt
The spread is inversely related to overall leverage of the banking system: in particular,
when banks are scarcely capitalized and capital constraints become more binding (i.e.
when leverage increases) margins become tighter.
2.2.2 Retail banking
Retail banking activity is carried out in a regime of monopolistic competition.
Loan branch: Retail loan branches obtain wholesale loans Bt (j) from the wholesale
b
unit at the rate Rt , differentiate them at no cost and resell them to households and firms
applying two distinct mark-ups. In order to introduce stickiness and study the implication
of an imperfect bank pass-through, we assume that banks face quadratic adjustment costs
for changing the rates they charge on loans; these costs are parametrized by κbE and κbH
and proportional - as standard in the literature - to aggregate deposits. The problem for
bH bE
retail loan banks is to choose {rt (j), rt (j)} to maximize:
∞
max E0 λP rt (j)bH (j) + rt (j)bE (j) − Rt Bt (j)−
0,t
bH
t
bE
t
b
{ bH bE
rt (j),rt (j)} t=0
bH 2 bE 2
κbH rt (j) κbE rt (j)
− bH
−1 rt bH −
bH
t bE
−1 rt bE
bE
t (10)
2 rt−1 (j) 2 rt−1 (j)
subject to demand schedules
bH −εbH bE −εbE
rt (j) t
rt (j) t
bH (j)
t = bH
bH ,
t and bE (j)
t = bE
bE
t
rt rt
with bH (j) + bE (j) = Bt (j).
t t
The first order conditions yield, after imposing a symmetric equilibrium,
2
Rt b bs
rt bs
rt λP rbs bs
rt+1 bE
1 − εbs + εbs
t t − κbs bs −1 bs + βP Et t+1 κbs t+1 − 1 t+1
= 0 , (11)
bs
rt rt−1 rt−1 λP
t
bs
rt bs
rt bE
t
with s = H, E. For the simplified case with non-stochastic εbs , the log-linearized version
t
of the loan-rate setting equations is
κbs βP κbs εbs − 1
t ˆ
ˆbs
rt = ˆbs
rt−1 + bs ˆbs
Et rt+1 + bs Rb
εbs − 1 + (1 + βP )κbs
t εt − 1 + (1 + βP )κbs εt − 1 + (1 + βP )κbs t
13
14. Loan rates are set by banks taking into account the expected future path of the wholesale
bank rate, which is the relevant marginal cost for this type of banks and which depends
on the policy rate and the capital position of the bank, as highlighted in equation (8) in
previous section.
With perfectly flexible rates, the pricing equation (11) becomes:
bs εbs
t
rt = Rb (12)
εbs − 1 t
t
As expected, in this case interest rates on loans are set as mark-up a over the marginal
cost. We can also calculate the spread between the loan and the policy rate with flexible
rates:
εbs 1
Stbs ≡ rt − rt = bs t StW + bs
bs
rt (13)
εt − 1 εt − 1
with the last equality obtained by combining (12) with the expression in (8). The spread
on retail loans is thus proportional to the wholesale spread StW , which is determined by
the bank capital position, and is increasing in the policy rate. In addition, the degree
of monopolistic competition also plays a role, as an increase in market power (i.e. a
reduction in the elasticity of substitution εbs determines - ceteris paribus - a wider spread.
t
This relation between the elasticity and the loan spread allows us to interpret shocks to
εbs , which we model as a stochastic process, as exogenous innovations to the bank loan
t
margin.
Deposit branch: Retail deposit branches perform a similar, but reversed, operation with
respect to deposits. They collect deposits dt (j) from households and then pass the raised
funds to the wholesale unit, which pays them at rate rt . The problem for the deposit
d
branch is to choose the retail deposit rate rt (j), applying a monopolistically competitive
mark-down to the policy rate rt , in order to maximize:
∞ d 2
κd rt (j)
max E0 λP rt Dt (j) − rt (j)dt (j) −
0,t
d
d
−1 d
rt Dt (14)
{rt (j)}
d
t=0
2 rt−1 (j)
subject to deposits demand
d εd
rt (j) t
dt (j) = d
Dt
rt
with dt (j) = Dt (j); the term containing κd is the quadratic adjustment costs for changing
the deposit rate. After imposing a symmetric equilibrium, the first-order condition for
optimal deposit interest rate setting is
2
rt rtd d
rt λP
t+1
d
rt+1 d
rt+1 dt+1
−1 + εd
t − εd d
t − κd −1 d + βP Et κd −1 = 0 . (15)
rt d
rt−1 rt−1 λP
t rtd
rtd dt
14
15. For a simplified case in which εd is non-stochastic, the linearized version of the previous
equation is
κd βP κd 1 + εd
ˆd
rt = ˆd
rt−1 + ˆd
Et rt+1 + rt
ˆ
1 + εd + (1 + βP )κd 1 + εd + (1 + βP )κd 1 + εd + (1 + βP )κd
which shows that banks set the deposit interest rate according to a sort of “interest-rate
Phillips curve” (hatted values denote percentage deviations from the steady-state). By
solving the equation forward, one could see that the deposit interest rate is set taking into
account the expected future level of the policy rate. The speed of adjustment to changes
in the policy rate depends inversely on the intensity of the adjustment costs (as measured
by κd ) and positively on the degree of competition in the banking sector (as measured by
the inverse of εd ). With fully flexible rates, rt is determined as a static mark-down over
d
the policy rate:
εd εd
d
rt = d t
rt = d t rt (16)
εt − 1 εt + 1
where the last equality follows from the fact that εd < 0.
t
Overall profits of bank j are the sum of earnings from the wholesale unit and the retail
branches. After deleting the intra-group transactions, their expression is:
2
κKb Ktb (j)
Jtb (j) = rt (j)bH (j)+rt (j)bE (j)−rt (j)dt (j)−
bH
t
bE
t
d
− νb Ktb (j)−AdjtB (j) (17)
2 Bt (j)
where AdjtB (j) indicates adjustment costs for changing interest rates on loans and deposits.
2.3 Retailers
At the retail level, we assume monopolistic competition and quadratic price adjustment
costs, which make prices sticky. In the adjustment cost function for prices, the parameter
κp denotes the parameters measuring the size of these costs, while ιp measures the degree
of indexation to past prices.
Retailers are just “branders”: they buy the intermediate good from entrepreneurs at
the wholesale price PtW and differentiate the goods at no cost. Each retailer then sales
their unique variety at a mark-up over the wholesale price. The elasticity of substitution εy
t
faced by retailers is assumed to follow and AR(1) process with autoregressive coefficient ρy
and i.i.d. normal innovations with standard deviation σy . We also assume that retailers’
prices are indexed to a combination of past and steady-state inflation, with relative weights
parametrized by ζ; if they want to change their price beyond what indexation allows, they
face a proportional adjustment cost. In a symmetric equilibrium, the (non-linearized)
15
16. Phillips curve is given by the retailers’ problem first-order condition:
εy cP−aPcP yt+1
εy
t
ζ
1 − + t − κp (πt − πt−1 π 1−ζ )πt + βP Et tP
t−1 ι
κ (π − πt P π 1−ιP )πt+1
PcP p t+1
=0
xt ct+1−a t yt
(18)
W
where xt = Pt /Pt is the gross markup earned by retailers.
2.4 Capital goods producers
Introducing capital good producers (CGPs) is a modeling device to derive a market price
for capital, which is necessary to determine the value of entrepreneurs’ collateral, against
which banks concede loans. We assume that, at the beginning of each period, each
capital good producer buys an amount it (j) of final good from retailers and the stock of
old undepreciated capital (1 − δ)kt−1 from entrepreneurs (at a nominal price PtK ). Old
capital can be converted one-to-one into new capital, while the transformation of the final
good is subject to quadratic adjustment cost; the amount of new capital that CGPs can
produce is given by
2
qk
κi εt it (j)
kt (j) = (1 − δ)kt−1 (j) + 1 − − 1 it (j) (19)
2 it−1 (j)
where κi is the parameter measuring the cost for adjusting investment and εqk is a shock
t
to the productivity of investment goods. This shock has an AR(1) representation with
autoregressive coefficient ρqk and i.i.d normally distributed with zero mean innovations
with standard deviation equal to σqk .
The new capital stock is then sold back to entrepreneurs at the end of the period at the
nominal price Ptk . Market for new capital is assumed to be perfectly competitive, so that
it can be shown that CPGs’ profit maximization delivers a dynamic equation for the real
k
price of capital qt = Ptk /Pt similar to Christiano et al. (2005) and Smets and Wouters
(2003). 6
2.5 Monetary policy
A central bank is able to exactly set the interest rate prevailing in the interbank market
rt , by supplying all the demanded amount of funds in excess of the net liquidity position
in the interbank market.7 We assume that profits made by the central bank on seignorage
6
As pointed out by BGG (1999), a totally equivalent expression for the price of capital can be obtained
by internalizing the capital formation problem within the entrepreneurs’ problem; the analogous to our
k
qt is nothing but the usual Tobin’s q. In using a decentralized modeling strategy, we follow Christiano
et al. (2005).
7
From an operational point of view, we are assuming that monetary policy is conducted as in the
Eurosystem, but with a zero-width policy-rate corridor.
16
17. are evenly rebated in a lump-sum fashion to households and entrepreneurs. In setting the
policy rate, the monetary authority follows a Taylor rule of the type
φy (1−φR )
πt φπ (1−φR ) Yt
(1 + rt ) = (1 + r)(1−φR ) (1 + rt−1 )φR εR
t (20)
π Yt−1
where φπ and φy are the weights assigned to inflation and output stabilization, respectively,
r is the steady-state nominal interest rate and εR is an exogenous shock to monetary policy
t
with normal distribution and standard deviation σr .
2.6 Aggregation and market clearing
Equilibrium in the goods market is expressed by the resource constraint
k
Yt = Ct + qt [Ct − (1 − δ)Kt−1 ] + Kt ψ (ut ) + Adjt (21)
where Ct denotes aggregate consumption and is given by
Ct = cP + cI + cE
t t t (22)
Yt = γ E yt (i) is aggregate output and Kt = γ E kt (i) is the aggregate stock of physical
E E
capital. The term Adjt includes real adjustment costs for prices, wages and interest rates.
Equilibrium in the housing market is given by
¯
h = γ P hP (i) + γ I hI (i) (23)
t t
¯
where h denotes the exogenous fixed housing supply stock.
3 Estimation
3.1 Methodology and data
We linearize the equations describing the model around the steady state. The solution
takes the form of a state-space model that is used to compute the likelihood function.
We use a Bayesian approach and choose prior distributions for the parameters which are
added to the likelihood function; the estimation of the implied posterior distribution of
the parameters is done using the Metropolis algorithm (see Smets and Wouters, 2007 and
Linde at al. 2007). We use ten observables: real consumption, real investment, real house
prices, real deposits, real loans to households and firms, the minimum bid rate on the
main refinancing operations, the interest rates on deposits, loans to firms and households,
wage inflation and consumer price inflation. For a description of the data see appendix A.
The sample period runs from 1998:1 to 2008:4. We remove the trend from the variables
17
18. using the HP filter. We also estimated the model with linearly detrended and obtained
very similar results in terms of the posterior distribution of the parameters of the model.
We estimate the parameters that affect the dynamics of the model and calibrate those
determining the steady state in order to obtain reasonable values for some key steady-state
values and ratios. Table 1 reports the values of the calibrated parameters.8
3.2 Calibrated parameters and prior distributions
Calibrated parameters We set the patients’ discount factor at 0.9943, in order to
obtain a steady-state interest rate on deposits slightly above 2 per cent on an annual basis,
in line with the average monthly rate on M2 deposits in the euro area between January
1998 and December 2008.9 As for impatient households’ and entrepreneurs’ discount
factors βI and βE , we set them at 0.975, in the range suggested by Iacoviello (2005) and
Iacoviello and Neri (2008). The mean value of the weight of housing in households’ utility
function εh is set at 0.2, close to the value in Iacoviello and Neri (2008). As for the
j
loan-to-value (LTV) ratios, we set mI at 0.7 in line with evidence for mortgages in the
¯
main euro area countries (0.7 for Germany, 0.5 for Italy and 0.8 for France and Spain), as
pointed out by Calza et al. (2007). The calibration of mE is somewhat more problematic:
¯
Iacoviello (2005) estimates a value of 0.89, but, in his model, only commercial real estate
can be collateralized; Christensen et al. (2007), estimate a much lower value (0.32), in a
model for Canada where firms can borrow against business capital. Using data over the
period 1999-2008 for the euro area we estimate an average ratio of long-term loans to the
value of shares and other equities for the non financial corporations sector of around 0.41;
using short-term instead of long-term loans we obtain a smaller value of around 0.2. Based
on this evidence, we decide to set mE at 0.25. These LTV ratios imply a steady-state
¯
shares of household and entrepreneur loans equal to 49 and 51 per cent, respectively.
The capital share is set to 0.25 and the depreciation rate to 0.025. In the labor market
we assume a markup of 15 per cent and set l at 5. In the goods market, a value of 6 for y
in steady state delivers a markup of 20 percent, a value commonly used in the literature.
For the banking parameters, no corresponding estimates are available in the literature.
Thus, we calibrate them so as to replicate some statistical properties of bank interest
rates and spreads. Equation (16) shows that the steady-state spread between the deposit
8
Estimation is done with Dynare 4.0.
9
The rate on M2 deposits was constructed by taking a weighted average of the rates on overnight
deposits, time deposits up to 2 years and saving deposits up to 3 months, with the respective outstanding
amounts in each period as weights. Data on interest rates were obtained from the official MIR statistics
by the ECB, starting from January 2003; previous to that date, we used monthly variations of non-
harmonized interest rates for the EMU-12, provided by the BIS, to reconstruct back the series. Similarly,
for loan rates we used ECB official interest rates on new-business loans to non-financial corporations and
on loans for house purchase to households since January 2003, and we reconstructed back the series by
using variations of non-harmonized rates before that date.
18
19. rate and the interbank rate depends on εd ; thus, to calibrate εd we calculate the average
t ¯
monthly spread between banking rates in our sample and the 3-month Euribor, which
corresponds to around 150 basis points on an annual basis, implying that εd = −1.3.
¯
bH bE
Analogously, we calibrate εt and εt by exploiting the steady-state relation between the
marginal cost of loan production and household and firm loan rates. The steady state
H E
ratio of bank capital to total loans (Bt + Bt ) is set to 0.09, slightly above the capital
requirements imposed by Basel II. The parameter δ b is set at the value (0.0982) that
ensures that the ratio of bank capital to total loans is exactly 0.09.
Prior distributions Our priors are listed in Tables 2A and 2B. Overall, they are
either consistent with the previous literature or relatively uninformative. For the persis-
tence, we choose a beta-distribution with a prior mean of 0.8 and standard deviation of
0.1. We set the prior mean of the habit parameters in consumption ah = aP = aI = aE
at 0.5 (with a standard error of 0.1). For the monetary policy specification, we assume
prior means for φR , φπ and φY equal, respectively, to 0.75, 2.0 and 0.1. We set the prior
mean of the parameters measuring the adjustment costs for prices κp and wages κw to,
respectively, 50 and 100 with standard deviations of 50. The priors for the indexation
parameters ιp and ιw are loosely centered around 0.5, as in Smets and Wouters (2007).
As for the mean of the adjustment costs for interest rates, their mean is set to 20 and the
standard deviation to 10. These priors include the values that have been estimated using
a small scale VAR, which included the bank interest rates on deposits, loans to households
and loans to firms, the three-month money market rate and a monthly measure of output,
estimated over the period 1999:1 2008:12. The impact response to an exogenous increase
of 25 basis points in the three-month rate is equal to 3 basis points for the interest rate on
deposits, and to 17 and 15 basis points for the interest rates on loans to households and
to firms, respectively. These responses imply adjustment costs equal to 11 for deposits
(κd ), 6 for loans to households (κbH ) and 5 for the loans to firms (κbE ).
3.3 Posterior estimates
Tables 2A and 2B report the posterior mean, median and 95 probability intervals for the
structural parameters, together with the mean and standard deviation of the prior distri-
butions. Draws from the posterior distribution of the parameters are obtained using the
random walk version of the Metropolis algorithm. We run 10 parallel chains each of length
200,000. The scale factor was set in order to deliver acceptance rates between 20 and 30
percent. Convergence was assessed by means of the multivariate convergence statistics
taken from Brooks and Gelman (1998). Figures 2 and 3 report the prior and posterior
marginal densities of the parameters of the model, excluding the standard deviation of
the innovations of the shocks.
All shocks are quite persistent with the only exception of the price markup shock. As
19
20. far as monetary policy is concerned our estimation confirm the weak identification of the
response to inflation (see Figure 3) and the relatively large degree of interest rate inertia.
The posterior median of the coefficient measuring the response to output growth is larger
(3) than the prior mean. Concerning nominal rigidities, we find that wage stickiness is
more important than price stickiness. The degree of price indexation is relatively low (the
median is 0.15) and confirms the finding of Benati (2008) who documents a reduction in
indexation in the euro area in the post-1999 sample. Concerning the parameters measuring
the degree of stickiness in bank rates, we find that deposit rates adjustment more rapidly
than the rates on loans to changes in the policy rate. This results is not surprising given
that our measure of deposits include also time and saving deposits. The interest rates on
these instruments, indeed, is typically more responsive to changes in money market rates
than those on overnight deposits. In all the cases the median is smaller than the mean of
the prior distribution.
The median values of the marginal posterior distribution of the parameters We set the
prior mean of the parameters measuring the adjustment costs for prices κp and wages κw
to, respectively, 50 and 100 with standard deviations of 50. The priors for the indexation
parameters ιP and ιW are loosely centered around 0.5, as in Smets and Wouters (2007).
As for the mean of the adjustment costs for interest rates, their mean is set to 20 and the
standard deviation to 10.
4 Properties of the estimated model
In this Section we study the dynamics of the linearized model using impulse responses,
focusing on a contractionary monetary policy shock and on an expansionary technology
innovation. Our aim is to assess whether and how the transmission mechanism of mone-
tary and technology shocks is affected by the presence of financial frictions and financial
intermediation and how different our findings are from those of other papers that share
some of our features, such as Iacoviello (2005), Christiano et al. (2007) or Goodfriend
and McCallum (2007). At the same time we want to analyze the impact of this types of
shocks on the profitability and capital position of financial intermediaries, a task that our
model is suited to accomplish.
4.1 Monetary policy shock
The transmission of a monetary policy shock is first studied by analyzing the impulse
responses to an unanticipated 50 basis points exogenous shock to the policy rate (rt ) (see
Figure 4). The benchmark model, described in the previous sections, features a number of
transmission channels for monetary impulses. Besides the traditional interest rate channel,
modified by the presence of agents with an heterogeneous degree of patience, there exist
20
21. three more channels: a borrowing constraint channel by which an innovation in the policy
rate, by changing the net present value of the collateral, changes how binding agents’
constraints are; moreover, there exist a financial accelerator effect, by which induced
changes in asset price alter the value of the collateral agents can pledge. Finally, the
assumption that interest and principal payments on loans and deposits are in nominal
terms introduces a nominal debt channel, whereby changes in inflation affect the ex-post
distribution of resources across borrowers and lenders. All these last three factors have
been shown to contribute to amplify and propagate the initial impulse of a monetary
tightening (see, e.g., Iacoviello, 2005, or Calza et al., 2007). Adding to their effects, the
presence of a banking sector affects the monetary transmission mechanism by impinging
on each of them. In particular, credit market power, sluggishness in bank rates and the
presence of bank capital might dig wedges between rates set by the policymaker and rates
which are relevant for the decisions of each agent in the economy. The overall effect on
the transmission mechanism of monetary policy could in principle be ambiguous.
In order to highlight how the various channel affect the transmission of monetary policy,
in figure 4 we compare our (benchmark) model (BK in the figure) with a number of other
models, where we progressively shut down a number of features: (i) a model where we
shut down the bank-capital channel, i.e. a model with a simplified balance-sheet for banks,
including only deposits on the liability side (noBK in the figure);10 (ii) a model where
we also remove stickiness in bank-interest rate setting and allow for flexible rates (FR in
the figure); 11 (iii) a model with perfectly competitive banks, i.e. most resembling to the
single interest rate model with financial frictions in Iacoviello (2005) (FF inthe figure);12
(iv) a model where we also remove the financial accelerator and debt-deflation effects, in
order to obtain a model similar to the standard New Keynesian DSGE.13
In the benchmark model, the presence of financial intermediation and capital con-
straints does not qualitatively alter the responses of the main macroeconomic variables,
when compared to standard results in the New Keynesian literature. Therefore, our model
has the advantage to introduce new elements, thus enriching the inter-linkages between
macroeconomic and financial variables, while remaining able to replicate stylized facts in
business cycle theory. In the face of a policy tightening, output and inflation contract
and the policy rate does not rise one-to-one with the exogenous shock, because it endoge-
nously responds to the fall in output and inflation. Loans to both households and firms
fall, reflecting the decline in asset prices, i.e. the price of housing and the value of firms’
10
In order to do so, we force the parameter κKb to be equal to 0 and we rebate banking profits to
patient households in a lump-sum fashion.
11
Operationally, we set the costs to change rates κbH , κbE and κd to zero.
12
This model is obtained by assuming that the elasticities of substitution for loans and deposits all
equal infinity.
13
Here agents are assumed to be still constrained in borrowing but at the steady state value of the
collateral, and loans and deposits (plus interest) are repaid in real terms.
21
22. capital, and the increase in the real interest rate. Bank loan rates increase less than the
policy rate (on impact, the increase is around one fourth) but they remain above steady
state for longer, reflecting the imperfect pass-through of lending rates; the loan-deposit
interest margin also goes up, as the increase in the deposit rate is even less pronounced.
The response of bank capital is initially positive, reflecting the increase in bank margins
and thus profit, but it subsequently falls as spreads reduce and financial activity remains
subdued.
From a quantitative point of view, however, a number of differences arises from the
the introduction of financial intermediation. In general, our banking sector attenuates
the responses with respect to a model featuring a single interest rate (FF model in the
figure). This is because monopolistic competition in banking introduces a steady-state
wedge between retail bank rates and the policy rates, on the one hand, and also allows for
imperfect pass-through on bank rates (due to adjustment costs) which mutes the response
of retail rates to the increase in the official rate. The introduction of a link between the
capital position of banks and the spread on loans has, instead, virtually no effect on
the dynamics of the real variables; this partly reflects the small value estimated for the
parameter κKb, which - as mentioned before - we use to perform this exercise. To give
an example, our calibration implies that a reduction of the capital-to-asset ratio by half
(from its steady state value of 9%) would increase the spread between loan rates and the
policy rate by only 20 basis points.
Analyzing more in detail the differences between the various models, the presence of the
financial accelerator is clearly evident when comparing the model with financial frictions
(and no banks; FF model) with the model where this channel is shut down (QNK model).
The role of banks begins to appear when we take into account the responses of the FR
and of the noBK models, which add a (simplified) banking sector to the FF framework; in
both these models, there is a wedge between active and passive rates as a consequence of
the market power of banks and pass-through on bank rates is imperfect. The FR model
isolates the attenuating effect coming from imperfect competition in the credit market.
This comes from a steady state effect according to which a given (absolute) monetary
tightening impinges on a loan rate which is already higher, by a measure of the markup,
than the policy rate, therefore determining a smaller percent variation of the former
rate. Sticky bank rates (noBK model) add to this, preventing banks to fully pass on the
policy rate increase to retail rates. From the figure, it is evident that the attenuator effect
resulting from the presence of banks can be sizeable on impact. Finally, when we compare
the noBK and the BK model, we disentangle the effect on real variables of the presence of
banking capital. Bank capital rises substantially following the shock but turns negative
after 10 quarters; overall, the impact of the shock is very persistent, suggesting that the
introduction of this feature can potentially add much to the propagation mechanism.
Movements in bank capital follow the dynamics of bank profits (which in our model
22
23. correspond to interest margin): these rise on impact, when the increase in rate spreads
more than offsets the fall in intermediated funds, but later become negative (after around
5 quarters), when spreads reduce to zero (and intermediation activity remains subdued).
The increase in equity seems to determine some substitution effect with deposits, whose
relative cost has increased; such substitution prevents movements in equity to have any
significant impact on credit and, thus, on the real economy.
Our findings about the relative strength of the effects coming from the financial fric-
tions and the banking sector are in line with much of the available literature. Christensen
et al. (2007) find that financial frictions boost the response of output after an increase
in policy rates by about a third, mainly on account of a stronger response of both con-
sumption and investment. As for the role of banks, Christiano et al. (2007) find that, in
general, the presence of banks and financial frictions strengthens significantly the prop-
agation mechanism of monetary policy: the output response is both bigger and more
persistent compared to a model that does not feature these channels. Although their
banks, compared to ours, are rather different intermediaries that operate under perfect
competition, they also find that banks play a marginal role in propagating the monetary
impulse while the financial accelerator is more important. An attenuation effect coming
from banks similar to ours has been found in Goodfriend and McCallum (2007) banking
model. In their model, the effect occurs only when the monetary impulse is very persis-
tent, since marginal costs in the banking sector become procyclical in that case (otherwise
the effect is of opposite sign). The attenuation effect in our model is more general, as
bank rate adjustment is sluggish irrespective of the persistence of monetary shocks. A
similar attenuator effect from the presence of a steady-state spread in the banking sector,
due to imperfectly competitive financial intermediation, arises also in Andr´s and Arce
e
(2008) and Aslam and Santoro (2008).
4.2 Technology shock
The transmission of a technology shock is studied by looking at the impulse responses
coming from the same set of models illustrated in the previous paragraph. Figure 5 shows
the simulated responses of the main macroeconomic and financial variables following a
shock to aE equal in size to the estimated standard deviation of TFP.
t
In the case of a technology shock the presence of financial intermediation substantially
enhances the endogenous propagation mechanism after the shock, with output peaking
higher and 2 to 4 quarters later than in the model with financial frictions and without
banks (FF). This effect reflects mainly the behavior of investment, whose response is
significantly magnified by the presence of financial intermediaries.
In all models, the shock makes production more efficient, bringing inflation down.
Monetary policy accommodates the fall in inflation bringing down also loan rates, and
23
24. therefore increasing loans, aggregate demand and output. When we introduce a monopo-
listically competitive banking sector (with flexible rates, FR), the reduction in the policy
rate translates into a reduction of credit spreads, which increases the demand for loans.
Both impatient households and entrepreneurs, benefitting from the greater availability
of credit, accumulate housing and physical capital, which allows them to borrow even
more and to enjoy a persistent expansion of consumption. As a result, there the effects of
the shock on both consumption and investment is more persistent: the peak increase in
consumption is reached in the beginning of the third year, i.e. one year later with respect
to the model without banks; the rise in investment is very pronounced and also its peak
is delayed.
When we add to this basic mechanism sticky bank rates (the noBK model) the pic-
ture does not change substantially, although the reduction of spreads is dampened by
the imperfect pass-through, determining a smaller impact reaction of lending and, thus,
of consumption and investment. The introduction of bank capital has a relevant impact
on investment, going mainly through the reduction of the availability of credit to en-
trepreneurs. In addition, the reduction in capital - by affecting the bank capital position
- also affects the loan margin, dampening the reduction described above.
5 Applications
Once the model has been estimated and its propagation mechanism studied, we can use
it to address the two questions raised in the Introduction. First, what role did the shocks
originating in the banking system played in the dynamics of the main variables since the
burst of the financial crisis? Second, what are the effects of a credit crunch originating
from a fall in bank capital?
5.1 The role of financial shocks in the business cycle
In order to quantify the relative importance of each shock in the model we perform an
historical decomposition of the dynamics of the main macro and financial variables of
the euro area. This decomposition was obtained by fixing the parameters of the model
at the posterior mode and then using the Kalman smoother to obtain the values of the
innovations for each shock. The aim of the exercise is twofold: on the one hand, we want
to investigate how our financially-rich model interprets the slowdown in 2008 and thus
learn from the model which shocks were mainly responsible for the current slowdown. On
the other hand, to the extent that the overall story told by the model is consistent with
the common wisdom emerged so far about the origins and causes of the current crises, we
can use this experiment as an indirect misspecification test for our model.
For this exercise we have divided the 13 shocks that appear in the model in three groups.
24
25. First there is a “macroeconomic” group, which pulls together shocks to the production
technology, to intertemporal preferences, to housing demand, to the investment-specific
technology, and to price and wage markups. Then, the “monetary policy” group isolates
the contribution coming from the non-systematic conduct of the monetary policy. Finally,
the “financial” group consists of shocks originating in the banking system: those are the
shocks to the loan-to-value ratios on loans to firms and households, the shocks to the
markup on the bank interest rates and the shock to the balance sheet.
Figure 6 shows the results of the exercise for some macro variables. Concerning output
(defined as the sum of consumption and investment) the results of the historical decompo-
sition suggest that financial shocks were primary drivers behind both the rise of 2006-2007
and the sharp slowdown of 2008. In particular, these shocks explain about 60 per cent of
the slowdown in economic activity in the last three quarters of 2008. The financial shocks
affect the real economy mainly through their effect on investment and the decomposition
of that variable confirms how unusually large (positive) shocks were responsible for the
positive performance of investment in 2006 and 2007 and how these same shocks turned
negative in 2008, accounting for the fall in investment. The other main culprit behind the
slowdown of 2008 are, obviously, negative macroeconomic shocks. Looking a bit closer
into that category, it turns out that an important contributor in this group were price
markup shocks. The reason why these shocks are estimated to be so important in the
current juncture is that they are likely to be capturing the effects of the sharp increase
in commodity prices that occurred in the first half of 2008. The large contribution of
these shocks to inflation confirms this hypothesis.Turning to the policy rate, the macroe-
conomic shocks exerted a positive contribution during most of 2008. According to the
model monetary policy shocks had negative effects on the policy rate between the end of
2007 and the third quarter of 2008. In order to understand this result, one has to recall
that over this period, which was characterized by great uncertainty on the consequences
of the financial crisis, the ECB kept the interest rate on the main refinancing operations
fixed at 4.0 per cent until July 2008 when it was raised by 25 basis points in order to
counteract inflationary pressures stemming from the surge in commodity prices. Since
mid-2008, the contribution of the banking shocks become predominant and fully account
for the rapid reduction in the policy rate in the last quarter of 2008.
In Figure 7 we collect the results of the historical decomposition for some credit vari-
ables. In this case we find convenient to divide the “financial” group in three sub-
categories: shocks directly related to loans to households (loan-to-value ratio for HH
and interest rate markup shock on loans to HH), shocks directly related to loans to firms,
and the rest of financial shocks (markup shock on deposit rate and bank balance sheet
shock). The dynamics of the interest rates on loans to firms and households were mainly
driven by macroeconomic shocks. However, shocks related to the firms side of credit
played an important role in driving up the rate on loans to firms since 2005, while mon-
25
26. etary policy shocks were relatively important drivers between 2006 and 2007, when the
ECB raised the policy rate from the very low levels reached in June 2003. Concerning
loans to households, a main driver of its dynamics turned out to be the housing shock
(within the macro group), since it explains most of the strong rise in 2006 and 2007 and
of the subsequent decline in 2008. This is not surprising given the role of housing as
collateral for the households in obtaining credit. Beside the housing shock, a important
role in the recent fall is played by the high price markup shocks (within the macro group)
estimated in 2008, which, as we said earlier, are likely to be capturing the sharp increase
in commodity prices that occurred in the first half of 2008. Loans to firms are driven
almost exclusively by shocks related directly to the firms side of credit, with the notable
exception of 2008 when a sizable negative contribution comes from the macroeconomic
shocks (in particular, again, the price markups).
To sum up, the exercise taught us that the banking shocks introduced in our model have
played an important role in shaping the dynamics of the euro area in the last business
cycle and, more importantly, according to the model they did so in a way that nicely
squares with our prior knowledge and expert judgement of macroeconomists about what
has happened.
5.2 The effects of a tightening of credit conditions
Starting in the summer of 2007, financial markets in a number of advanced economies fell
under considerable strain. The initial deterioration in the US sub-prime mortgage market
quickly spread across other financial markets, affecting the valuation of a number of assets.
Banks, in particular, suffered losses from significant write-offs on complex instruments
and reported increasing funding difficulties, in connection with the persisting tensions in
the interbank market and with the substantial hampering of securitization activity. A
number of them were forced to recapitalize and improve their balance sheets. In addition,
intermediaries reported that concerns over their liquidity and capital position induced
them to tighten credit standards for the approval of loans to the private sector. In the euro
area, since the October 2007 round, banks participating to the Eurosystem’s quarterly
Bank Lending Survey reported to have strongly increased the margins charged on average
and riskier loans and to have implemented a restriction on collateral requirements both
for households and firms; in each 2008 Survey release, 30% of respondent banks reported
to have reduced the loan-to-value ratio for house purchase mortgages in the previous three
months. Against this background, policymakers have been particularly concerned with
the impact that a restriction in the availability and cost of credit might have on the real
economy. The potential consequences on economic activity of the financial turmoil have
been given considerable attention when evaluating the appropriateness of the monetary
policy stance.
In light of the importance of understanding the consequences of a tightening of credit
26
27. standards by banks, in this section we try to answer the following question: What would
happen if bank capital were to suffer a strong negative shock? Would it trigger a contrac-
tion in loan supply, an increase in bank rates and a contraction in economic activity?
Our model is well-suited to analyze the effects of a tightening in credit conditions on the
real activity and to give indications (at least qualitatively) on the appropriate response
of a central bank following a Taylor-type monetary policy rule. The experiment we carry
out involves implementing an unexpected and persistent contraction in bank capital Kb .
We do not attempt to construct a quantitatively realistic scenario; this would be indeed
very difficult, given the conflicting indications coming from hard and survey evidence on
the tightening of credit standards, in particular in the euro area, and the uncertainty on
the effects that have already occurred and on those that might still be in the pipeline.
We calibrate the shock in a way that it determines a fall of bank capital by 5 percent
on impact. The persistence of the shock is set to 0.95 in order to obtain a persistent
fall of the capital/asset ratio below its steady state value (9 percent). In the exercise we
assess the role of the adjustment costs on the capital/asset ratio by computing the impulse
responses under different calibration of the parameters κKb . We consider as benchmark
a value of 10, the prior mean of the parameters, and then a higher one, corresponding to
50, and a lower one equal to 2. Figure 8 shows the effect of this credit crunch experiment.
By construction, the credit tightening brings about a fall in bank capital. In order to
compensate for the loss in equity, banks increase the rate on deposits to attract them and
increase their liabilities. At the same time, they increase the rates on loans to increase
profits. At this point, the larger is the cost for adjusting the capital ratio, the larger is the
increase in banks’ interest rates. Higher rates reduce the demand for loans by households
and firms which are forced to cut back on consumption and investment expenditure. The
effect is larger on investment; the size of the response of consumption depends largely
on the persistence of the shock to bank capital (see Figure 8). When the persistence of
the shock is reduced to 0.5, consumption marginally increases while investment still falls
substantially. Output contracts only when the adjustment costs on the capital ratio is
sufficiently large. In this scenario, interest rates on loans and deposits still increase and
loan demand falls; profits increase and compensate the fall in equity. The capital ratio
converges faster to its steady state.
Looking at individual agents, the rate shock unfavorably hits impatient households,
through the increase in the real interest rate they face on loans, who are forced to sell their
housing in order to support consumption. House prices fall and patient households start
investing in housing by reducing consumption. Entrepreneurs reduce the accumulation
of capital and consumption. Aggregate demand falls considerably and output contracts
significantly.
27
28. 6 Concluding remarks
The paper has presented a model in which both entrepreneurs and impatients households
face borrowing constraints and loans are supplied by imperfectly competitive banks that
collect deposits from patient households. Deposits and bank capital are used to produce
loans that are granted to households and firms. Bank interest rates on these distinct loans
and on deposits adjust slowly to changes in the policy rate. The model is estimated using
Bayesian techniques and data for the euro area over the period 1999-2008.
We find that in the face of demand shocks, like a monetary policy shock, the presence
of financial intermediaries diminishes the business cycle acceleration effects deriving from
a change of the real net present value of agents’ collateral. The presence of bank capital
does not alter the effects of monetary policy shocks on the main macroeconomic variables.
On the contrary, banks intermediation increases the propagation of supply shock like
technological improvements.
The model is then used to quantify the contribution of shocks originating within the
banking sector to the slowdown in economic activity during 2008 and to study the conse-
quences of tightening of credit conditions induced by a reduction in bank capital. Shocks
in the banking sector explain the largest fraction of the fall output in 2008 while macroeco-
nomic shocks played a smaller role. The effects of a credit supply shock can be substantial
particularly on investment. A fall in bank capital forces bank to raise interest rates re-
sulting in lower demand for loans by households and firms who are forced to cut on
consumption and expenditure.
28
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29