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Unexpected loan losses and bank capital in an estimated DSGE model of the euro area

Nikolay Hristov and Oliver Hülsewig

Journal of Macroeconomics, 2017, vol. 54, issue PB, 161-186

Abstract: We present a stylized DSGE model in which banks face unexpected losses in their loan portfolios and are subject to capital regulation. The framework is used to explore the importance of the interaction between macroeconomic conditions, credit default and bank capitalization for the transmission of macroeconomic shocks. We fit the model to euro area data. Impulse response analysis shows that the aforementioned interaction substantially magnifies the responsiveness of the economy to demand side and monetary disturbances. The amplification is especially strong with respect to government spending shocks. The model is further capable of replicating two financial market characteristics that are documented in the empirical literature, i.e. the pro-cyclicality of bank profitability and the counter-cyclical response of firm default rates and credit spreads to monetary policy shocks.

Keywords: DSGE model; Bank capital; Aggregate loan losses; Business cycle fluctuations (search for similar items in EconPapers)
JEL-codes: E44 E51 G21 G33 (search for similar items in EconPapers)
Date: 2017
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Working Paper: Unexpected Loan Losses and Bank Capital in an Estimated DSGE Model of the Euro Area (2016) Downloads
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DOI: 10.1016/j.jmacro.2017.02.001

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