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Financial Intermediation And The International Business Cycle: The Case Of Small Countries With Big Banks

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Executive Summary

The authors examine the transmission mechanism of banking sector shocks in a two-country DSGE model. Assuming that the home country is small relative to the rest of world, they find that spillovers from foreign banking sector shocks are modest unless banks in the small country hold foreign banking assets. The correlation between home and foreign GDP rises with the exposure of the domestic banking sector to foreign bank assets. Including a banking sector into an otherwise standard international real business cycle model does not significantly alter the transmission mechanism of productivity shocks.

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