Financial Intermediation, Sudden Stops and Financial Crises

Albert Queralto and Ozge Akinci
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Albert Queralto: Federal Reserve Board

No 1332, 2013 Meeting Papers from Society for Economic Dynamics

Abstract: This paper develops a small open economy business cycle model with financial intermediaries (banks) in which banks' endogenous leverage constraints are occasionally binding. The model can account for financial crashes and sudden stops as a result of the amplification and asymmetry induced by the leverage constraint. When the leverage constraint is not binding, the model mimics the responses of macroeconomic aggregates to shocks of a typical frictionless real business cycle model. The constraint binds only if banks' leverage is sufficiently high. When this happens, the economy may experience a severe financial crisis in response to typical realizations of shocks. The theoretical framework developed in the paper is suitable to study the effectiveness of ex-ante macroeconomic policies designed to eliminate the excessive risk taking of financial intermediaries in the face of high and volatile capital flows.

Date: 2013
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