Banks’ Balance Sheets and the Macroeconomy in the Bank of Italy Quarterly Model

Abstract

We investigate the relationship between macroeconomic conditions and banks' balance sheets by referring to a modified version of the Bank of Italy Quarterly Model (BIQM), regularly used for forecasting and policy analysis. In particular, we examine how regulatory bank capital and private sector default probabilities affect interest rates on loans and, ultimately, economic activity. To this end, we build an enriched version of the model to include a number of banking variables. The changes introduced in the model result in an amplification of the responses of macroeconomic variables to monetary policy and world demand shocks, although, in normal times, the effect is not large.

Keywords: bank regulatory capital, loan interest rates, Italian economy

JEL Classification: E17, E27, E51, G21