The Macroeconomics of Modigliani-Miller

47 Pages Posted: 3 Apr 2013

See all articles by Hans Gersbach

Hans Gersbach

ETH Zurich - CER-ETH -Center of Economic Reseaarch; IZA Institute of Labor Economics; CESifo (Center for Economic Studies and Ifo Institute); Centre for Economic Policy Research (CEPR)

Hans H. Haller

Virginia Polytechnic Institute & State University - Department of Economics

Jürg Müller

ETH Zürich - CER-ETH - Center of Economic Research at ETH Zurich

Date Written: March 2013

Abstract

We examine the validity of a macroeconomic version of the Modigliani-Miller theorem. For this purpose, we develop a general equilibrium model with two production sectors, risk-averse households and financial intermediation by banks. Banks are funded by deposits and (outside) equity and monitor borrowers in lending. We impose favorable manifestations of the underlying frictions and distortions. We obtain two classes of equilibria. In the first class, the debt-equity ratio of banks is low. The first-best allocation obtains and banks' capital structure is irrelevant for welfare: a macroeconomic version of the Modigliani-Miller theorem. However, there exists a second class of equilibria with high debt-equity ratios. Banks are larger and invest more in risky technologies. Default and bailouts financed by lump sum taxation occur with positive probability and welfare is lower. Imposing minimum equity capital requirements eliminates all inefficient equilibria and guarantees the global validity of the macroeconomic version of the Modigliani-Miller theorem.

Keywords: Banking, Capital Requirements, Capital Structure, Financial intermediation, General Equilibrium, Modigliani-Miller

JEL Classification: D53, E44, G2

Suggested Citation

Gersbach, Hans and Haller, Hans H. and Müller, Jürg, The Macroeconomics of Modigliani-Miller (March 2013). CEPR Discussion Paper No. DP9402. Available at SSRN: https://ssrn.com/abstract=2244082

Hans Gersbach (Contact Author)

ETH Zurich - CER-ETH -Center of Economic Reseaarch ( email )

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IZA Institute of Labor Economics

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Germany

CESifo (Center for Economic Studies and Ifo Institute)

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Germany

Centre for Economic Policy Research (CEPR)

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United Kingdom

Hans H. Haller

Virginia Polytechnic Institute & State University - Department of Economics ( email )

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Blacksburg, VA 24061
United States
540-231-7591 (Phone)
540-231-5097 (Fax)

Jürg Müller

ETH Zürich - CER-ETH - Center of Economic Research at ETH Zurich

No Address Available

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