DP8985 | Global Banks, Financial Shocks and International Business Cycles: Evidence from an Estimated Model

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21/05/2012

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Abstract

This paper estimates a two-country model with a global bank, using US and Euro Area (EA) data, and Bayesian methods. The estimated model matches key US and EA business cycle statistics. Empirically, a model version with a bank capital requirement outperforms a structure without such a constraint. A loan loss originating in one country triggers a global output reduction. Banking shocks matter more for EA macro variables than for US real activity. During the Great Recession (2007-09), banking shocks accounted for about 20% of the fall in US and EA GDP, and for more than half of the fall in EA investment and employment.