Credit Defaults, Bank Lending and the Real Economy

58 Pages Posted: 2 Sep 2016

See all articles by Sebastiaan Pool

Sebastiaan Pool

De Nederlandsche Bank - Research Department

Date Written: August 25, 2016

Abstract

This paper examines how the materialization of credit defaults affects the real economy. I estimate a DSGE model including banks, firms and financial frictions using euro area data. The estimation results show that a positive credit default shock, which is identified as an unanticipated increase in credit default losses, complicates monetary policy because output falls while inflation goes up. The monetary authority must choose between stabilizing output and inflation and is therefore less effective. Inflation increases slightly because firms experience besides a demand contraction also a cost-push effect when banks increase the lending rate. Countercyclical capital buffers can in this case complement conventional monetary policy but there is a trade-off: they effectively attenuate macroeconomic fluctuations, but increase the persistence of the slump as banks rebuild their capital more slowly. A bank recapitalization overcomes this trade-off and significantly reduces macroeconomic fluctuations.

Keywords: Banking, Credit risk, Credit defaults, Countercyclical Capital Buffer, Bayesian Estimation

JEL Classification: E44, E51, E52

Suggested Citation

Pool, Sebastiaan, Credit Defaults, Bank Lending and the Real Economy (August 25, 2016). De Nederlandsche Bank Working Paper No. 518. Available at SSRN: https://ssrn.com/abstract=2833281 or http://dx.doi.org/10.2139/ssrn.2833281

Sebastiaan Pool (Contact Author)

De Nederlandsche Bank - Research Department ( email )

P.O. Box 98
1000 AB Amsterdam
Netherlands

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