Endogenous Entry, Banking, and Business Cycle

Carla La Croce () and Lorenza Rossi

No 72, DEM Working Papers Series from University of Pavia, Department of Economics and Management

Abstract: We consider a DSGE model with flexible prices, monopolistic competitive banks and sticky interest rates, together with endogenous firms exit and entry decisions. We find that economies characterized by endogenous firms dynamics imply higher volatilities of both real and financial variables than those implied by a DSGE with monopolistic banking and a fixed number of firms, in response to both real and financial shocks. The model with endogenous exit, in line with the empirical evidence, implies: i) countercyclical exit; ii) an endogenous countercyclical bank markup and an endogenous countercyclical interest rate spread; iii) a quicker recovery in the aftermath of a financial crisis, when the macroprudential authority implements countercyclical capital requirements (Basel III). This policy is more stabilizing than Basel II as well as than an alternative Taylor rule explicitly targeting capital-to-asset ratio.

Keywords: firms endogenous exit; bank markup; interest rate spread; macro- prudencial policies; Taylor rule. (search for similar items in EconPapers)
JEL-codes: E32 E44 E52 E58 (search for similar items in EconPapers)
Pages: 31 pages
Date: 2014-03
New Economics Papers: this item is included in nep-ban, nep-dge and nep-mac
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (9)

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