Collateral Shocks, Lending Relationships and Economic Dynamics

Vol: 
49/2023
Author name: 
Sharma V
Year: 
2023
Month: 
October
Abstract: 

What are the effects of changing bank lending conditions in a model in which borrowers have endogenously-persistent credit relationships with lenders? This paper answers this question in a simple Two-Agent New Keynesian (TANK) setup. Fluctuations in collateral requirements, termed collateral shocks in this paper, result in a rise in spread, a drop in bank credit and amplification of macroeconomic volatility. These effects are amplified by presence of lending relationships and are greater at higher persistence and volatility of the collateral shocks. The results in this paper underscore that credit relationships matter when collateral shocks hit the economy and a model that assumes away the existence of these lending relationships, risks underestimating their effects.

Publication file: 

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