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Financial Dampening

Johannes Wieland () and Mu-Jeung Yang

No 22141, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We propose a novel mechanism, “financial dampening,” whereby loan retrenchment by banks attenuates the effectiveness of monetary policy. The theory unifies an endogenous supply of illiquid local loans and risk-sharing among subsidiaries of bank holding companies (BHCs). We derive an IV-strategy that separates supply-driven loan retrenchment from local loan demand, by exploiting linkages through BHC-internal capital markets across spatially-separate BHC member-banks. We estimate that retrenching banks increase loan supply substantially less in response to exogenous monetary policy rate reductions. This relative decline has persistent effects on local employment and thus provides a rationale for slow recoveries from financial distress.

JEL-codes: E5 E50 E51 E52 G20 G21 (search for similar items in EconPapers)
Date: 2016-03
New Economics Papers: this item is included in nep-mac and nep-mon
Note: CF EFG ME
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Published as JOHANNES F. WIELAND & MU‐JEUNG YANG, 2020. "Financial Dampening," Journal of Money, Credit and Banking, vol 52(1), pages 79-113.

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Working Paper: Financial Dampening (2015) Downloads
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