Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/66866 
Authors: 
Year of Publication: 
2012
Series/Report no.: 
DIW Discussion Papers No. 1242
Publisher: 
Deutsches Institut für Wirtschaftsforschung (DIW), Berlin
Abstract: 
This paper argues that counter-cyclical liquidity hoarding by financial intermediaries may strongly amplify business cycles. It develops a dynamic stochastic general equilibrium model in which banks operate subject to financial frictions and idiosyncratic funding liquidity risk in their intermediation activity. Importantly, the amount of liquidity reserves held in the financial sector is determined endogenously: Balance sheet constraints force banks to trade off insurance against funding outflows with loan scale. The model shows that an aggregate shock to the collateral value of bank assets triggers a flight to liquidity, which amplifies the initial shock and induces credit crunch dynamics sharing key features with the Great Recession. The paper thus develops a new balance sheet channel of shock transmission that works through the composition of banks' asset portfolios rather than fluctuations in borrower net worth as in the financial accelerator literature.
Subjects: 
real business cycles
financial frictions
liquidity hoarding
bank capital channel
credit crunch
JEL: 
E22
E32
E44
Document Type: 
Working Paper

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