Bank Credit and Default in Infinite Horizon

36 Pages Posted: 4 Dec 2019

See all articles by Charles Goodhart

Charles Goodhart

London School of Economics & Political Science (LSE) - Financial Markets Group

Dimitrios P. Tsomocos

University of Oxford - Said Business School and St. Edmund Hall

Xuan Wang

VU University Amsterdam; Tinbergen Institute

Date Written: November 14, 2019

Abstract

Ever since the Great Financial Crisis, if not before, it has become clear that there are complex interactions between the real and nominal sectors of the economy. When do monetary and financial policy goals conflict with each other? When is monetary policy a complement to or a substitute for macroprudential policy? What is the role of money-financed fiscal expansion and its impact on allocations, prices, and financial stability? We develop a dynamic stochastic general equilibrium (DSGE) model featuring deposit issuance via bank credit and endogenous default. We argue that the official policy rate and the financial wedge, namely the spread between loan and deposit rates, are the key variables for the analysis of the interaction between price stability and financial fragility. We show that both the monetary policy rate and the financial wedge exert real effects, even though prices are fully flexible. We establish, first, that contractionary monetary policy is, typically, unable to lean effectively against the wind during periods of financial deregulation; second, that capital requirements often have procyclical effects; third, that monetary policy is more effective when the economy is more liquidity-constrained; and fourth, that money-financed fiscal expansion is effective in raising output and inflation, and accompanied with lower credit risks.

Keywords: default, bank credit and inside money, price-level determinacy and financial stability, bank capital regulation

JEL Classification: E41, E44, E51, E63

Suggested Citation

Goodhart, Charles A.E. and Tsomocos, Dimitrios P. and Wang, Xuan, Bank Credit and Default in Infinite Horizon (November 14, 2019). Available at SSRN: https://ssrn.com/abstract=3491217 or http://dx.doi.org/10.2139/ssrn.3491217

Charles A.E. Goodhart

London School of Economics & Political Science (LSE) - Financial Markets Group ( email )

Houghton Street
London WC2A 2AE
United Kingdom
0207 955 7555 (Phone)
0207 242 1006 (Fax)

Dimitrios P. Tsomocos (Contact Author)

University of Oxford - Said Business School and St. Edmund Hall ( email )

Park End Street
Oxford, OX1 1HP
Great Britain
+44 1865 288 932 (Phone)
+44 1865 288 805 (Fax)

Xuan Wang

VU University Amsterdam ( email )

De Boelelaan 1105
Amsterdam, ND North Holland 1081 HV
Netherlands

HOME PAGE: http://https://sites.google.com/view/xuan-wang

Tinbergen Institute ( email )

Gustav Mahlerplein 117
Amsterdam, 1082 MS
Netherlands

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
70
Abstract Views
529
rank
454,597
PlumX Metrics