Work

Financial Intermediation, Leverage, and Macroeconomic Instability

Year: 2016

Type: article

Abstract: This paper investigates how financial sector leverage affects macroeconomic instability and welfare. In the model, banks borrow (use leverage) to allocate resources to productive projects and pro vide liquidity. When banks do not actively issue new equity, aggregate outcomes depend on the level of equity in the financial sector. Equilibrium is inefficient because agents do not internalize how their decisions affect volatility, aggregate leverage, and the returns on assets. Leverage creates systemic risk, which increases the frequency and duration of crises. Limiting leverage decreases asset price volatility and increases expected returns, which decrease the likelihood that the financial sector is undercapitalized. (JEL E32, E44, G01, G21)

Source: American Economic Journal Macroeconomics

DOI: 10.1257/mac.20140233

Author: Gregory Phelan

Institution: Williams College

Language: English

Topic: Banking stability, regulation, efficiency

Subfield: Finance

Field: Economics, Econometrics and Finance

Domain: Social Sciences

SDG: Decent work and economic growth

Open Access status: green

OpenAlex ID: W829049488

FWCI: 8.924

Cites: 29

Cited by: 50

Related to: 10