Working Paper No. 487
By Roland Meeks, Benjamin D Nelson and Piergiorgio Alessandri
We develop a macroeconomic model in which commercial banks can offload risky loans to a ‘shadow’ banking sector, and financial intermediaries trade in securitised assets. We analyse the responses of aggregate activity, credit supply and credit spreads to business cycle and financial shocks. We find that: interactions and spillover effects between financial institutions affect credit dynamics; high leverage in the shadow banking system makes the economy excessively vulnerable to aggregate disturbances; and following a financial shock, stabilisation policy aimed solely at the securitisation markets is relatively ineffective.
Shadow banks and macroeconomic instability