Banks, Credit Market Frictions, And Business Cycles

Provided by: Bank of Canada Topic: CXO Date Added: Jul 2010 Format: PDF
This paper proposes a fully micro-founded framework that incorporates an active banking sector into a DSGE model with a financial accelerator. Then, it evaluates the role and importance of banks' behavior and financial shocks in U.S. business cycles. The banking sector consists of two types of profit-maximizing banks that offer different banking services and transact in an interbank market. Loans are produced using interbank borrowing and bank capital subject to a bank capital requirement condition. Banks have monopoly power, set nominal deposit and prime lending rates, choose their leverage ratio and their portfolio composition, and can endogenously default on a fraction of their interbank borrowing.

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