Bank Competition And Economic Stability: The Role Of Monetary Policy

This paper analyzes the dual role of monetary policy for economic efficiency and stability in a model of endogenous bank competition. Multiple equilibria emerge from the complementarity between bank and non-financial firm decisions. Adverse aggregate or idiosyncratic liquidity shocks may cause a breakdown in which the economy collapses into no-production equilibrium. Less bank competition improves the profitability of banks and makes the economy less vulnerable to adverse shocks but it also distorts the efficient allocation of capital.