Financial Intermediation, Resource Allocation, and Macroeconomic Interdependence
No 201704, Discussion Paper Series, School of Economics and Finance from School of Economics and Finance, University of St Andrews
This paper studies the role of the financial sector in affecting domestic resource allocation and cross-border capital flows. I develop a quantitative, two-country, macroeconomic model in which banks face endogenous and occasionally binding leverage constraints. Banks lend funds to be invested in tradable or non-tradable sector capital and there is international financial integration in the market for bank liabilities. I focus on news about economic fundamentals as the key source of fluctuations. Specifically, in the case of positive news on the valuation of non-traded sector capital that turn out to be incorrect at a later date, the model generates an asymmetric, belief-driven boom-bust cycle that reproduces key features of the recent Eurozone crisis. Bank balance sheets amplify and propagate fluctuations through three channels when leverage constraints bind: First, amplified wealth effects induce jumps in import-demand (demand channel). Second, changes in the value of non-tradable sector assets alter bank lending to tradable sector firms (intra-national spillover channel). Third, domestic and foreign households re-adjust their savings in domestic banks, and capital flows further amplify fluctuations (international spillover channel). A common central bank’s unconventional policies of private asset purchases and liquidity facilities in response to unfulfilled expectations are successful at ameliorating the economic downturn.
Keywords: Bank Lending; Belief-Driven Dynamics; Current Account; Macroeconomic Interdependence (search for similar items in EconPapers)
JEL-codes: E44 F32 F41 G15 G21 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-mac and nep-opm
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Working Paper: Financial Intermediation, Resource Allocation, and Macroeconomic Interdependence (2017)
Working Paper: Financial intermediation, resource allocation, and macroeconomic interdependence (2016)
Working Paper: Financial Intermediation, Resource Allocation, and Macroeconomic Interdependence (2015)
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