Working Paper: CEPR ID: DP10964
Authors: Hans Gersbach; Jean-Charles Rochet; Martin Scheffel
Abstract: This paper integrates a simple model of banks into a two-sector neoclassical growth model. The integration yields an analytically tractable framework with two coupled accumulation rules for household capital and bank equity. We analyze steady state properties, transition and recovery patterns, as well as policies to accelerate recoveries. After establishing existence, uniqueness and global stability of the steady state, we identify in particular five key results and predictions, and we provide a quantitative assessment. First, larger financial frictions in financial intermediation may increase banker wealth although total capital is depressed. Second, negative shocks to bank equity cause considerably larger downturns than comparable shocks to household wealth, but their persistence is similar. Third, temporary worsening of shocks to financial frictions (called "trust shocks") induces divergent reactions of household wealth and bank equity, causes a boom in the banking sector, and possibly in the economy ? after an initial bust. Fourth, the model replicates typical patterns of financing over the business cycle: procyclical bank leverage, procyclical bank lending, and counter-cyclical bond financing. Finally, a combination of bailouts and dividend-payout-restrictions ensures a rapid build-up of bank equity after a slump in the banking sector and increases total production.
Keywords: banking crises; business cycles; bust-boom cycles; capital accumulation; financial intermediation; macroeconomic shocks; recovery policies
JEL Codes: E21; E32; F44; G21; G28
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Larger financial frictions (G19) | Increase in banker wealth (F65) |
| Larger financial frictions (G19) | Depress total capital (E22) |
| Negative shocks to bank equity (F65) | Larger economic downturns (E32) |
| Negative shocks to bank equity (F65) | Prolonged effects on macroeconomic performance (E60) |
| Temporary worsening of financial frictions (F65) | Divergent reactions in household wealth and bank equity (G59) |
| Temporary worsening of financial frictions (F65) | Initial economic boom following a downturn (E32) |
| Economic cycles (E32) | Procyclical patterns of bank leverage and lending (E44) |
| Bailouts and restrictions on dividend payouts (G28) | Rapid recovery in bank equity (G21) |