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Taking Banks to Solow


Scheffel, Martin; Gersbach, Hans; Rochet, Jean-Charles (2015). Taking Banks to Solow. CEPR Discussion Paper DP10439, University of Zurich.

Abstract

We develop a simple integration of banks into the Solow model. The objective is to provide a tractable benchmark for analyzing the long-term impact of crises on economic activities and growth. A fraction of firms have to rely on banks for financing their investments while banks face themselves an endogenous leverage constraint. Informed lending by banks and uninformed lending through capital markets spur capital accumulation. The ensuing coupled accumulation rules for household wealth and bank equity yield a uniquely determined steady state. We highlight three properties when shocks to wealth, productivity or trust affect the economy. First, typically bond and loan financing react in opposite directions to such shocks. Second, negative temporary shocks to household wealth (financial crisis) or negative sectoral production shocks can surprisingly cause persistent booms of banking and even of the entire economy -- after an initial bust. Third, shocks to bank equity (banking crisis), however, lead to large and persistent downturns associated with high output losses.

Abstract

We develop a simple integration of banks into the Solow model. The objective is to provide a tractable benchmark for analyzing the long-term impact of crises on economic activities and growth. A fraction of firms have to rely on banks for financing their investments while banks face themselves an endogenous leverage constraint. Informed lending by banks and uninformed lending through capital markets spur capital accumulation. The ensuing coupled accumulation rules for household wealth and bank equity yield a uniquely determined steady state. We highlight three properties when shocks to wealth, productivity or trust affect the economy. First, typically bond and loan financing react in opposite directions to such shocks. Second, negative temporary shocks to household wealth (financial crisis) or negative sectoral production shocks can surprisingly cause persistent booms of banking and even of the entire economy -- after an initial bust. Third, shocks to bank equity (banking crisis), however, lead to large and persistent downturns associated with high output losses.

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Additional indexing

Item Type:Working Paper
Communities & Collections:03 Faculty of Economics > Department of Banking and Finance
Dewey Decimal Classification:330 Economics
Language:English
Date:24 February 2015
Deposited On:18 Feb 2016 10:10
Last Modified:28 Aug 2017 20:09
Series Name:CEPR Discussion Paper
Number of Pages:28
Free access at:Official URL. An embargo period may apply.
Official URL:http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2569268
Other Identification Number:merlin-id:11699

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