A Macroeconomic Model With Financially Constrained Producers and Intermediaries

Abstract

How much capital should financial intermediaries hold? We propose a general equilibrium model with a financial sector that makes risky long‐term loans to firms, funded by deposits from savers. Government guarantees create a role for bank capital regulation. The model captures the sharp and persistent drop in macro‐economic aggregates and credit provision as well as the sharp change in credit spreads observed during financial crises. Policies requiring intermediaries to hold more capital reduce financial fragility, reduce the size of the financial and non‐financial sectors, and lower intermediary profits. They redistribute wealth from savers to the owners of banks and non‐financial firms. Pre‐crisis capital requirements are close to optimal. Counter‐cyclical capital requirements increase welfare.

Can Monetary Policy Create Fiscal Capacity?

“…We solve the model globally using time iteration. We extend the solution method proposed by Elenev, Landvoigt, and Van Nieuwerburgh (2021). Since that model is a real model without monetary policy, the nominal side of the model is new.…”

“…3. Given the guessed value ω (i) 0 , solve the model using transition function iteration as in Elenev et al (2021). We discretize the exogenous process into N e = 3 states using the Rouwenhorst (1995) method and define rectangular grids for 3 endogenous state variables: log market value of government debt logŴ G , aggregate capital K, and intermediary wealth share…”

“…We choose the equity payout target of banks, τ = 0.08 we to target leverage of the intermediary sector, calculated by Elenev, Landvoigt, and Van Nieuwerburgh (2021) to be 92%. 8 A higher value of τ , in combination with the equity issuance cost, makes equity finance more costly for banks and creates incentives for higher leverage.…”

“…8 A higher value of τ , in combination with the equity issuance cost, makes equity finance more costly for banks and creates incentives for higher leverage. We further follow Elenev et al (2021) in calibrating the equity issuance cost to target the net payout ratio of the financial sector, defined as dividends plus share repurchases minus equity issuance divided by book equity. A higher equity issuance cost makes external equity more expensive and raises the net payout ratio.…”

“…A higher equity issuance cost makes external equity more expensive and raises the net payout ratio. Elenev et al (2021) construct a time series of dividends, share repurchases, equity issuances, and book equity, aggregating across all publicly traded banks from 1974 − 2018. They report an annual net payout ratio of 5.7%, which the model approximately matches with χ = 25.…”