Global Banks, Financial Shocks and International Business Cycles: Evidence from an Estimated Model

Abstract

This paper estimates a two-country model with a global bank, using US and Euro Area (EA) data, and Bayesian methods. The estimated model matches key US and EA business cycle statistics. Empirically, a model version with a bank capital requirement outperforms a structure without such a constraint. A loan loss originating in one country triggers a global output reduction. Banking shocks matter more for EA macro variables than for US real activity. During the Great Recession (2007-09), banking shocks accounted for about 20% of the fall in US and EA GDP, and for more than half of the fall in EA investment and employment. JEL codes: F36, F37, E44, G21* Robert Kollmann, ECARES, CP 114, Université Libre de Bruxelles; 50 Av. Franklin Roosevelt, B-1050 Brussels, Belgium. 32-2-650-4474. robert_kollmann@yahoo.com. Matthias Paustian contributed to this project in its early stages--I thank him for his advice and for computer code. I also thank Werner Roeger for many discussions. Helpful comments and suggestions were also received from Gernot Müller, Alan Sutherland, Christoph Thoenissen, Ken West, Egon Zakrajšek and participants at several workshops.

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