Balance-Sheet Shocks and Recapitalizations
IMF Working Papers, March 1, 2012
Source details
- Canonical URL
- Balance-Sheet Shocks and Recapitalizations
Other formats
Bibliographic details
- Authors: Damiano Sandri, Fabian Valencia
- Published: March 1, 2012
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781463938451.001
Summary of model and approach
- Develops a dynamic stochastic general equilibrium model with financial frictions on both financial intermediaries and goods-producing firms.
- Emphasizes high leverage of financial intermediaries as a key channel making balance sheet disruptions in the financial sector particularly detrimental for aggregate output.
Main findings
- Welfare gains from recapitalizing the financial sector in response to large but rare net worth losses are as large as those from eliminating business cycle fluctuations.
- These welfare gains:
- Are increasing in the size of the net worth loss.
- Are larger when recapitalization funds are raised from the household sector rather than the real sector.
- May increase with a reduction in financial intermediaries idiosyncratic risk.
Policy-relevant implications
- Recapitalization of the financial sector can generate welfare improvements comparable to removing business cycle volatility, highlighting the macroeconomic importance of targeted recapitalization policies in large balance-sheet shocks.
- The design of recapitalization funding matters: raising funds from households is associated with larger welfare gains than taxing or otherwise drawing funds from the real sector.
- Policies that reduce financial intermediaries’ idiosyncratic risk can amplify the welfare benefits of recapitalizations.
Subject and keywords (as provided)
- Subject: Economic sectors; Economic theory; Financial frictions; Financial institutions; Financial sector; Labor; Nonbank financial institutions; Self-employment
- Keywords: agency problem; balance-sheet shocks; bank bailouts; business cycle; Financial accelerator; Financial frictions; Financial sector; gains from recapitalization; Global; leverage; Nonbank financial institutions; recapitalization fund; recapitalization policy; recapitalization process; recapitalization share; Self-employment; welfare gain; WP