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Working Papers

Financial Cycles with Heterogeneous Intermediaries

Coimbra, N, Rey, H
  Latest Draft: 01 Mar 2017,

Abstract:
This paper develops a dynamic macroeconomic model with heterogeneous financial intermediaries and endogenous entry. It features time-varying endogenous macroeconomic risk that arises from the risk-shifting behaviour of financial intermediaries combined with entry and exit. We show that when interest rates are high, a decrease in interest rates stimulates investment and increases financial stability. In contrast, when interest rates are low, further stimulus can increase systemic risk and induce a fall in the risk premium through increased risk-shifting. In this case, the monetary authority faces a trade-off between stimulating the economy and financial stability.



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Helene Rey thanks the ERC for financial support (ERC Advanced Grant 695722)




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