MARTIN Gets a Bank Account: Adding a Banking Sector to the RBA's Macroeconometric Model
Mike Major () and
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Peter Rickards: Reserve Bank of Australia
RBA Research Discussion Papers from Reserve Bank of Australia
We add a simplified banking sector to the RBA's macroeconometric model (MARTIN). How this banking sector interacts with the rest of the economy chiefly depends on the extent of loan losses. During small downturns, losses are absorbed by banks' profits and the resulting effect on the broader economy is limited to that caused by the lower shareholder returns (which is already part of MARTIN). During large downturns, loan losses reduce banks' capital, and banks respond by reducing their credit supply. This reduction in supply reduces housing prices, wealth and investment; thereby amplifying the downturn (which leads to further losses). Our state-dependent approach is a significant advance on the treatment of financial sectors within existing macroeconometric models. Having a banking sector in MARTIN allows us to explore important policy questions. In this paper, we show how the effectiveness of monetary policy depends on the state of the economy. During large downturns, monetary policy is more effective than usual because it can reduce loan losses and therefore moderate any reduction in credit supply. But at low interest rates, the zero lower bound on retail deposit interest rates reduces policy effectiveness. We also investigate how one of the more pessimistic economic scenarios that could have resulted from COVID-19 might have affected the banking sector, and subsequently amplified the resulting downturn.
Keywords: banking; financial accelerator; macroeconomic model (search for similar items in EconPapers)
JEL-codes: E17 E44 E51 G21 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-ban, nep-cba, nep-cwa, nep-fdg, nep-mac and nep-mon
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Persistent link: https://EconPapers.repec.org/RePEc:rba:rbardp:rdp2022-01
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