Financial Capital and the Macroeconomy: A Quantitative Framework

Posted: 9 Jul 2021

See all articles by Michael T. Kiley

Michael T. Kiley

affiliation not provided to SSRN

Jae Sim

Board of Governors of the Federal Reserve System

Date Written: 2011

Abstract

Financial intermediation transforms short-term liquid assets into long-term capital assets. As a result, risk taking, in the form of long-term commitments despite unresolved short-term funding risk, is an essential element of intermediation. If such funding risk must be addressed by costly recapitalization and/or distressed asset sales due to capital market frictions, an increase in uncertainty can cause a disruption in the intermediation process by forcing risk-neutral intermediaries to behave in a risk-averse manner. Our analysis examines this behavior theoretically and empirically. We first develop a dynamic macroeconomic model in which the balance sheet/liquidity condition of financial intermediaries plays an important role in the determination of asset prices and economic activity under time-varying uncertainty. Second, we present new evidence on the importance of uncertainty facing financial intermediaries for credit terms and volume and for aggregate economic activity, thereby partially quantifying the significance of capital market frictions. We adopt a structural identification strategy in which the predictions of our theory, in the form of sign restrictions, play an important role.

Suggested Citation

Kiley, Michael T. and Sim, Jae W., Financial Capital and the Macroeconomy: A Quantitative Framework (2011). FEDS Working Paper No. 2011-27, Available at SSRN: https://ssrn.com/abstract=3876934

Michael T. Kiley (Contact Author)

affiliation not provided to SSRN

No Address Available

Jae W. Sim

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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