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The Role of Bank Capital in the Propagation of Shocks

Cesaire Meh () and Kevin Moran ()

Staff Working Papers from Bank of Canada

Abstract: Recent events in financial markets have underlined the importance of analyzing the link between the financial health of banks and real economic activity. This paper contributes to this analysis by constructing a dynamic general equilibrium model in which the balance sheet of banks affects the propagation of shocks. We use the model to conduct quantitative experiments on the economy's response to technology and monetary policy shocks, as well as to disturbances originating within the banking sector, which we interpret as episodes of distress in financial markets. We show that, following adverse shocks, economies whose banking sectors remain well-capitalized experience smaller reductions in bank lending and less pronounced downturns. Bank capital thus increases an economy's ability to absorb shocks and, in doing so, affects the conduct of monetary policy. The model is also used to shed light on the ongoing debate over bank capital regulation.

Keywords: Transmission of monetary policy; Financial institutions; Financial system regulation and policies; Economic models (search for similar items in EconPapers)
JEL-codes: E44 E52 G21 (search for similar items in EconPapers)
Pages: 37 pages
Date: 2008
New Economics Papers: this item is included in nep-ban, nep-cba, nep-cfn, nep-dge, nep-mac and nep-mon
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Journal Article: The role of bank capital in the propagation of shocks (2010) Downloads
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Persistent link: https://EconPapers.repec.org/RePEc:bca:bocawp:08-36

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