Taking Banks to Solow

28 Pages Posted: 24 Feb 2015

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)

Jean-Charles Rochet

Swiss Finance Institute; University of Geneva - Geneva Finance Research Institute (GFRI); University of Zurich - Swiss Banking Institute (ISB)

Martin Scheffel

affiliation not provided to SSRN

Date Written: February 2015

Abstract

We develop a simple integration of banks into the Solow model. The objective is to provide a tractable benchmark for analyzing the long-term impact of crises on economic activities and growth. A fraction of firms have to rely on banks for financing their investments while banks face themselves an endogenous leverage constraint. Informed lending by banks and uninformed lending through capital markets spur capital accumulation. The ensuing coupled accumulation rules for household wealth and bank equity yield a uniquely determined steady state. We highlight three properties when shocks to wealth, productivity or trust affect the economy. First, typically bond and loan financing react in opposite directions to such shocks. Second, negative temporary shocks to household wealth (financial crisis) or negative sectoral production shocks can surprisingly cause persistent booms of banking and even of the entire economy -- after an initial bust. Third, shocks to bank equity (banking crisis), however, lead to large and persistent downturns associated with high output losses.

Keywords: economic activity and growth, financial intermediation, impact of banking and financial crises, Solow model

JEL Classification: E21, E32, F44, G21, G28

Suggested Citation

Gersbach, Hans and Rochet, Jean-Charles and Scheffel, Martin, Taking Banks to Solow (February 2015). CEPR Discussion Paper No. DP10439, Available at SSRN: https://ssrn.com/abstract=2569268

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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CESifo (Center for Economic Studies and Ifo Institute)

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Centre for Economic Policy Research (CEPR)

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United Kingdom

Jean-Charles Rochet

Swiss Finance Institute ( email )

c/o University of Geneva
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CH-1211 Geneva 4
Switzerland

University of Geneva - Geneva Finance Research Institute (GFRI) ( email )

40 Boulevard du Pont d'Arve
Geneva 4, Geneva 1211
Switzerland

University of Zurich - Swiss Banking Institute (ISB) ( email )

Plattenstrasse 14
CH-8032 Zurich, Zurich 8032
Switzerland

Martin Scheffel

affiliation not provided to SSRN

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