Real Effects of Bank Shocks

Vivek Sharma

CAMA Working Papers from Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University

Abstract: What are the effects of a bank shock – or a decline in bank loan repayments – in an economy featuring bank-firm lending relationships and what is the propagation mechanism? I answer these questions in this paper and build a dynamic general equilibrium model in which collateral-constrained entrepreneurs have endogenously-persistent credit relationships with banks. Credit relationships play a dual role of shock amplifier and stabilizer in this environment. In presence of credit relationships, a bank shock in this model drives up credit spread at impact, causing bank credit to fall and paving the way for a downturn in macroeconomic activity. Economic activity recovers later on as spread falls, resulting in a rebound in bank loans and investment. When credit relationships are turned off, the model shows prolonged fall in bank loans and a persistent slowdown in investment, consumption and output as spread remains continually elevated, making bank credit expensive. A more persistent bank shock leads to a sustained decline in output even in the presence of lending relationships while a more volatile shock causes protracted slump in output in absence of credit relationships but not when they are present.

Keywords: bank shocks; lending relationships; economic activity (search for similar items in EconPapers)
JEL-codes: E32 E44 (search for similar items in EconPapers)
Pages: 52 pages
Date: 2024-12
New Economics Papers: this item is included in nep-dge and nep-fdg
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Persistent link: https://EconPapers.repec.org/RePEc:een:camaaa:2024-76

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