Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/62944 
Year of Publication: 
2012
Series/Report no.: 
Staff Report No. 567
Publisher: 
Federal Reserve Bank of New York, New York, NY
Abstract: 
We develop a theory of financial intermediary leverage cycles in the context of a dynamic model of the macroeconomy. The interaction between a production sector, a financial intermediation sector, and a household sector gives rise to amplification of fundamental shocks that affect real economic activity. The model features two state variables that represent the dynamics of the economy: the net worth and the leverage of financial intermediaries. The leverage of the intermediaries is procyclical, owing to risk-sensitive funding constraints. Relative to an economy with constant leverage, financial intermediaries generate higher output and consumption growth and lower consumption volatility in normal times, but at the cost of systemic solvency and liquidity risks. We show that tightening intermediaries' risk constraints affects the systemic risk-return trade-off by lowering the likelihood of systemic crises at the cost of higher pricing of risk. Our model thus represents a conceptual framework for cyclical macroprudential policies within a dynamic stochastic general equilibrium model.
Subjects: 
systemic risk
macroprudential policy
DSGE
amplification
capital regulation
financial intermediation
JEL: 
G00
G28
E32
E02
Document Type: 
Working Paper

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