Destabilizing Effects of Bank Overleveraging on Real Activity - An Analysis Based on a Threshold MCS-GVAR

24 Pages Posted: 28 Jun 2017

See all articles by Marco Gross

Marco Gross

International Monetary Fund (IMF); European Central Bank (ECB)

Jerome Henry

European Central Bank (ECB)

Willi Semmler

The New School - Department of Economics; Universitaet Bielefeld; IIASA

Date Written: June 21, 2017

Abstract

We investigate the consequences of overleveraging and the potential for destabilizing effects from financial- and real-sector interactions. In a theoretical framework, we model overleveraging and indicate how a highly leveraged banking system can lead to unstable dynamics and downward spirals. Inspired by Brunnermeier and Sannikov (2014) and Stein (2012), we empirically measure the deviation-from-optimal-leverage for 40 large EU banks. We then use this measure to condition the joint dynamics of credit flows and macroeconomic activity in a large-scale regime change model: A Threshold Mixed-Cross-Section Global Vector Autoregressive (T-MCS-GVAR) model. The regime-switching component of the model aims to make the relationship between credit and real activity dependent on the extent to which the banking system is overleveraged. We find significant nonlinearities as a function of overleverage. When leverage is standing above its equilibrium level, the effect of a deleveraging shocks on credit supply and economic activity are visibly more detrimental than at times of underleveraging.

Keywords: macro-financial linkages, overleveraging, credit supply

JEL Classification: E2, E6, C13, G6

Suggested Citation

Gross, Marco and Henry, Jerome and Semmler, Willi, Destabilizing Effects of Bank Overleveraging on Real Activity - An Analysis Based on a Threshold MCS-GVAR (June 21, 2017). ECB Working Paper No. 2081. Available at SSRN: https://ssrn.com/abstract=2993013

Marco Gross (Contact Author)

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Jerome Henry

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany
+49 69 1344 7614 (Phone)
+49 69 1344 6575 (Fax)

Willi Semmler

The New School - Department of Economics ( email )

65 Fifth Avenue
New York, NY 10003
United States

HOME PAGE: http://www.newschool.edu/nssr/faculty/?id=4e54-6b79-4e41-3d3d

Universitaet Bielefeld ( email )

Universitätsstraße 25
Bielefeld, NRW
Germany

IIASA ( email )

Schlossplatz 1
Laxenburg/Austria, A-2361
Austria

Here is the Coronavirus
related research on SSRN

Paper statistics

Downloads
22
Abstract Views
278
PlumX Metrics