Macroeconomic Implications of “Deep Habits” in Banking

Abstract

Recent empirical evidence shows that price-cost margins in the market for bank credit are countercyclical in the U.S. economy and that this cyclical behavior can be explained in part from the fact that switching banks is costly for customers (i.e., from a borrower hold-up effect). Our goal, in this paper, is to study the "financial accelerator" role of these countercyclical margins as a propagation mechanism of macroeconomic shocks. To do so, we apply the "deep habits" framework in Ravn, Schmitt-Grohé, and Uribe (2006) to financial markets to model this hold-up effect within a monopolistically competitive banking industry. We are able to reproduce the pattern of pricecost margins observed in the data, and to show that the real effects of aggregate total factor productivity shocks are larger the stronger the friction implied by borrower hold-up. Also, output, investment, and employment all become more volatile than in a standard model with constant margins in credit markets. An empirical contribution of our work is to provide structural estimates of the deep habits parameters for financial markets.JEL codes: E32, E44

Banking Competition, Housing Prices and Macroeconomic Stability

“…where t is the Lagrange multiplier on the ‡ow of funds constraint (2). The shadow value of installed capital, P k t ; is the familiar Tobin's Q:…”

“…2 Given this cost, borrowers optimally choose period by period their lending bank to maximize the discounted present value of their lifetime utility.…”

“…In this context, this model has been used including, among others, by Chiappori et al (1995), Freixas and Rochet (1997), Dell'Ariccia (2001) and Repullo (2004). 2 Of course, this utility cost is a pragmatic modelling device aimed at capturing the sources of monopolistic power by banks over and above those strictly related to literal transportation cost. But even the literal interpretation of geographical distance between lenders and borrowers as an explanatory variable for pricing and availability of credit has received some attention in the empirical literature (see e.g.…”

Fiscal Policy and Lending Relationships

“…The banking sector is borrowed from Aksoy et al (2009) andAliaga-Diaz andOlivero (2010). Each bank b chooses its demand for deposits, D bt+1 , and the loan rate, R L bt+1 , to maximize the expected discounted value of its lifetime pro ts.…”

“…It is a well-established fact in the empirical literature that the credit spread, i.e. the di erence between the loan rate and the deposit rate, widens during downturns (Gertler and Lown, 1999;Aliaga-Diaz and Olivero, 2010;Villa and Yang, 2011). Following the collapse of Lehman Brothers, the spread skyrocketed.…”