Credit cycles have been a characteristic of advanced economies for over 100 years. On average, a sustained pick-up in the ratio of credit to GDP has been highly correlated with banking crises. The boom phases of the cycle are characterised by large deviations in credit from trend. A range of mechanisms can generate these effects, each of which has strategic complementarity between banks at its core. Macro-prudential policy could curb these credit cycles, both through raising the cost of maintaining risky portfolios and through an expectations channel that operates via banks' perceptions of other banks' actions.
How does bank profitability vary with interest rates? We present a model of a monopolistically competitive bank subject to repricing frictions and test the model's predictions using a unique panel data set on UK banks. We find evidence that large banks retain a residual exposure to interest rates, even after accounting for hedging activity operating through the trading book. In the long run, both level and slope of the yield curve contribute positively to profitability. In the short run, however, increases in market rates compress interest margins, consistent with the presence of nonnegligible loan pricing frictions.
We develop a macroeconomic model in which commercial banks can offload risky loans to a 'shadow' banking sector, and financial intermediaries trade in securitized assets. We analyze the responses of aggregate activity, credit supply and credit spreads to business cycle and financial shocks. We find that: interactions and spillover effects between financial institutions affect credit dynamics; high leverage in the shadow banking system makes the economy excessively vulnerable to aggregate disturbances; and following a financial shock, stabilization policy aimed solely at the securitization markets is relatively ineffective.
Summary
Using VAR models for the USA, we find that a contractionary monetary policy shock has a persistent negative impact on the level of commercial bank assets, but increases the assets of shadow banks and securitization activity. To explain this “waterbed” effect, we propose a standard New Keynesian model featuring both commercial and shadow banks, and we show that the model comes close to explaining the empirical results. Our findings cast doubt on the idea that monetary policy can usefully “get in all the cracks” of the financial sector in a uniform way.
We present a gravity model that accounts for multilateral resistance, firm heterogeneity and countryselection into trade, while accommodating asymmetries in trade flows. A new equation for the proportion of exporting firms takes a gravity form, such that the extensive margin is also affected by multilateral resistance. We develop Taylor approximated multilateral resistance terms with which to capture the comparative static effects of changes in trade costs. For isolated bilateral changes in trade frictions, multilateral resistance effects are small for most countries. However, if all countries reduce their trade frictions, the impact of multilateral resistance is so strong that bilateral trade falls in most cases, despite the larger trade elasticities implied by firm heterogeneity. As a consequence, the worldwide trade response, though positive, is much lower.
Better international logistics raise a developing country's exports, but the magnitude of the effect depends on the country's size. We apply a gravity model that accounts for firm heterogeneity and multilateral resistance to an international logistics index. A one standard deviation improvement in logistics is equivalent to a 14% reduction in distance. An average‐sized developing country would raise exports by approximately 36%. Most of the countries are much smaller than average, so the typical effect is 8%. This difference is chiefly due to the dampening effect of multilateral resistance, which is more important for small countries.
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