RECEPCIÓN

We now consider the e¤ects of …nancial shocks that lead to exogenous declines in the bank’s

net worth or in the …rm’s net worth.124 _{The shock to the …rm’s net worth has been used in}

the numerous models with …nancial frictions at the …rm level (e.g. Christiano et al., 2010;

1 2 4

Following Holmstrom and Tirole (1997), the shock to the bank’s net worth might be interpreted as a credit crunch, since it is caused by sudden deteriorations in the balance sheets of the banks due to asset losses and the bank reduces the loan to non-…nancial …rms.

Nolan and Thoenissen, 2009).125 _{Recent upheavals in …nancial markets worldwide, charac-}

terised by growing asset losses and dramatic reductions in pro…ts of …nancial institutions,

appear to re‡ect disturbances of this kind (Meh and Moran, 2010).

Figure 3-6 jointly displays both the response to the bank’s net worth shock in the

bank friction model and the one to the …rm’s net worth shock in the …rm friction model.

The wealth shock is a negative one percent shock in the …rm’s net worth or in the bank’s

net worth, respectively. Output declines in both models, but the response of the …rm

friction model is much stronger than that of the bank friction model. And this di¤erence

mainly results from a stronger decline in investment.126 Specially, the responses of output

and investment in the …rm friction model are deeper and more persistent than the bank

friction model, whereas the instant responses are similar between the two models. In the

…rm friction model, the reduction of the …rm’s net worth increases the …rm’s leverage,

since the intermediate goods …rms need to borrow more to fund their capital stock. This

increase in leverage causes a rise in the external …nance premium, thus a drop in the price of

capital, which reinforces the initial drop in the net worth. This further lowers investment.

The decline of the bank’s net worth, meanwhile, increases capital asset ratio of the bank,

and this increases the external …nance premium, since increased bank’s leverage requires a

higher pro…tability. The implied increase in the …nancing cost causes a contraction of the

price of capital, thus, investment, and output.

Then, what makes the greater responses of output and investment in the …rm friction

model than the bank friction model? This di¤erence is related to the mechanism which

1 2 5

Christiano et al. (2010) suggested that this shock re‡ects irrational exuberance or asset price bubble, since it raises the …rm’s net wealth independently of movements in fundamentals. And Nolan and Thoenissen (2009) interpreted this shock as a shock to the e¢ ciency of contractual relations between borrowers and lenders.

1 2 6_{The trough of output is -0.30% and the one of investment is -1.94% in the …rm friction model. In the}

bank friction model, output declines in response to the shock and reaches a trough of -0.17% in quarter 4. The output contraction is mainly driven by a drop in investment, which declines by 0.52% on impact and reaches a trough of -1.09% in quarter 4.

causes more persistent responses of output and investment in the …rm friction model.

Particularly in the …rm friction model the negative shock to the …rm’s net worth increases

…nancial frictions and forces the …rm to invest less. This results in a lower level of capital

and further reduces the …rm’s net worth in the following period. This fall again leads

to lower investment and lowers the net worth in the following periods. However, the

bank friction model doesn’t have this kind of mechanism. In the bank friction model, as

explained in section 3.4.2.1 the decreased net worth of the bank increases the external

…nance premium and this lowers investment. But decreased investment means a fall of

the demand for the loan. This decreased demand for the loan rather lowers the external

…nance premium and investment rebounds with the decrease in …nancing costs. And this

increase of investment contributes to the recovery of the bank’s net worth. Through this

process the e¤ect of …nancial frictions is mitigated and the bank friction model shows less

persistent and lighter responses of output and investment than the …rm friction model.

The importance of the shock to the …rm’s net worth explained above is consistent with

Nolan and Thoenissen (2009). And this chapter shows that the shock to the bank’s net

worth reduces both output and in‡ation in the bank friction model. By contrast, in the

models of Gerali et al. (2010) and Meh and Moran (2010) this shock lowers output, but

increases in‡ation. This di¤erent response of in‡ation in these papers is connected to the

movement of wages. The contraction at the bank’s net worth causes the …rms to raise labour

demand to increase capital utilisation, pushing up wages. The higher wages and …nancing

costs result in the increase in in‡ation.127 Empirical studies on the macroeconomic e¤ects

of this wealth shock have mixed results. While Maddaloni et al. (2011), for the euro area,

found that their proxy for a shock to bank capital moves output and in‡ation in the same

direction, Fornari and Stracca (2012) also found that a negative shock to bank capital

1 2 7_{In contrast, in our bank friction model the labour demand falls following the reduction in investment}

persistently reduces output, but do not …nd a statistically signi…cant and robust decline of

in‡ation.

Figure 3-6. Response to wealth shocks