Working Paper No. 313
By Bojan Markovic
Recent empirical evidence based on microdata panels indicates the importance of banks' balance sheets for the monetary transmission mechanism. This paper builds a dynamic general equilibrium model to analyse the macroeconomic consequences of changes in the cost of bank capital, and thus the cost of bank credit. The model includes the interaction between the supply side (banking sector) and the demand side (corporate sector) of the credit market. The analysis suggests that bank capital channels may be an important part of the monetary transmission mechanism, particularly when there are large, direct shocks to banks' balance sheets. Such shocks could occur when there are structural changes that affect the banking system. The impulse responses are likely to be magnified due to the interaction between the supply and the demand sides of the credit market.