Financial Business Cycles

50 Pages Posted: 17 Sep 2014

See all articles by Matteo M. Iacoviello

Matteo M. Iacoviello

Federal Reserve Board - Trade and Financial Studies

Date Written: August 29, 2014


Using Bayesian methods, I estimate a DSGE model where a recession is initiated by losses suffered by banks and exacerbated by their inability to extend credit to the real sector. The event triggering the recession has the workings of a redistribution shock: a small sector of the economy – borrowers who use their home as collateral – defaults on their loans. When banks hold little equity in excess of regulatory requirements, the losses require them to react immediately, either by recapitalizing or by deleveraging. By deleveraging, banks transform the initial shock into a credit crunch, and, to the extent that some firms depend on bank credit, amplify and propagate the shock to the real economy. I find that redistribution and other financial shocks that affect leveraged sectors accounts for two-thirds of output collapse during the Great Recession.

Keywords: Banks; DSGE Models; Collateral Constraints; Housing; Bayesian Estimation

JEL Classification: E32, E44, E47

Suggested Citation

Iacoviello, Matteo M., Financial Business Cycles (August 29, 2014). FRB International Finance Discussion Paper No. 1116. Available at SSRN: or

Matteo M. Iacoviello (Contact Author)

Federal Reserve Board - Trade and Financial Studies ( email )

20th St. and Constitution Ave.
Washington, DC 20551
United States

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