Financial Dampening

56 Pages Posted: 4 Apr 2016

See all articles by Johannes Wieland

Johannes Wieland

University of California, San Diego (UCSD) - Department of Economics

Mu-Jeung Yang

University of Washington - Department of Economics

Date Written: March 2016

Abstract

We propose a novel mechanism, “financial dampening,” whereby loan retrenchment by banks attenuates the effectiveness of monetary policy. The theory unifies an endogenous supply of illiquid local loans and risk-sharing among subsidiaries of bank holding companies (BHCs). We derive an IV-strategy that separates supply-driven loan retrenchment from local loan demand, by exploiting linkages through BHC-internal capital markets across spatially-separate BHC member-banks. We estimate that retrenching banks increase loan supply substantially less in response to exogenous monetary policy rate reductions. This relative decline has persistent effects on local employment and thus provides a rationale for slow recoveries from financial distress.

Suggested Citation

Wieland, Johannes and Yang, Mu-Jeung, Financial Dampening (March 2016). NBER Working Paper No. w22141. Available at SSRN: https://ssrn.com/abstract=2758489

Johannes Wieland (Contact Author)

University of California, San Diego (UCSD) - Department of Economics ( email )

9500 Gilman Drive
La Jolla, CA 92093-0508
United States

Mu-Jeung Yang

University of Washington - Department of Economics ( email )

Box 353330
Seattle, WA 98195-3330
United States

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