Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/53948 
Authors: 
Year of Publication: 
2010
Series/Report no.: 
Bank of Canada Working Paper No. 2010-26
Publisher: 
Bank of Canada, Ottawa
Abstract: 
The author develops a dynamic stochastic general-equilibrium model with an active banking sector, a financial accelerator, and financial frictions in the interbank and bank capital markets. He investigates the importance of banking sector frictions on business cycle fluctuations and assesses the role of a regulatory capital requirement in propagating the effects of shocks in the real economy. Bank capital is introduced to satisfy the regulatory capital requirement, and serves as collateral for borrowing in the interbank market. Financial frictions are introduced by assuming asymmetric information between lenders and borrowers that creates moral hazard and adverse selection problems in the interbank and bank capital markets, respectively. Highly leveraged banks are vulnerable and therefore pay higher costs when raising funds. The author finds that financial frictions in the interbank and bank capital markets amplify and propagate the effects of shocks; however, the capital requirement attenuates the real impacts of aggregate shocks (including financial shocks), reduces macroeconomic volatilities, and stabilizes the economy.
Subjects: 
Economic models
Business fluctuations and cycles
Financial markets
Financial stability
JEL: 
E32
E44
G1
Persistent Identifier of the first edition: 
Document Type: 
Working Paper

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