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Discussion Paper Details

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Title: Taking Banks to Solow

Author(s): Hans Gersbach, Jean-Charles Rochet and Martin Scheffel

Publication Date: February 2015

Keyword(s): economic activity and growth, financial intermediation, impact of banking and financial crises and Solow model

Programme Area(s): Financial Economics and International Macroeconomics

Abstract: We develop a simple integration of banks into the Solow model. The objective is to provide a tractable benchmark for analyzing the long-term impact of crises on economic activities and growth. A fraction of firms have to rely on banks for financing their investments, while banks themselves face an endogenous leverage constraint. Informed lending by banks and uninformed lending through capital markets spur capital accumulation. The ensuing coupled accumulation rules for household wealth and bank equity yield a uniquely determined steady state. We highlight three properties when shocks to wealth, productivity or trust affect the economy. First, typically, bond and loan financing react in opposite directions to such shocks. Second, negative temporary shocks to household wealth (financial crisis) or negative sectoral production shocks can, surprisingly, cause persistent booms of banking and even of the entire economy ? after an initial bust. Third, shocks to bank equity (banking crisis), however, lead to large and persistent downturns associated with high output losses.

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Bibliographic Reference

Gersbach, H, Rochet, J and Scheffel, M. 2015. 'Taking Banks to Solow'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=10439