Taking Banks to Solow

Jean Rochet, Hans Gersbach and Martin Scheffel

No 10439, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: We develop a simple integration of banks into the Solow model. The objective is to provide a tractable benchmark for analyzing the long-term impact of crises on economic activities and growth. A fraction of firms have to rely on banks for financing their investments, while banks themselves face an endogenous leverage constraint. Informed lending by banks and uninformed lending through capital markets spur capital accumulation. The ensuing coupled accumulation rules for household wealth and bank equity yield a uniquely determined steady state. We highlight three properties when shocks to wealth, productivity or trust affect the economy. First, typically, bond and loan financing react in opposite directions to such shocks. Second, negative temporary shocks to household wealth (financial crisis) or negative sectoral production shocks can, surprisingly, cause persistent booms of banking and even of the entire economy ? after an initial bust. Third, shocks to bank equity (banking crisis), however, lead to large and persistent downturns associated with high output losses.

Keywords: Economic activity and growth; Financial intermediation; Impact of banking and financial crises; Solow model (search for similar items in EconPapers)
JEL-codes: E21 E32 F44 G21 G28 (search for similar items in EconPapers)
Date: 2015-02
New Economics Papers: this item is included in nep-ban, nep-gro and nep-mac
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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Chapter: Taking Banks to Solow (2016)
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