Financial cycles with heterogeneous intermediaries

Coimbra, N and Rey, H (2024) Financial cycles with heterogeneous intermediaries. Review of Economic Studies, 91 (2). pp. 817-857. ISSN 0034-6527

Abstract

We develop a dynamic macroeconomic model with heterogeneous financial intermediaries and endogenous entry. Time-varying endogenous macroeconomic risk arises from the risk-shifting behaviour of the cross-section of financial intermediaries. When interest rates are high, a decrease in interest rates stimulates investment and decreases aggregate risk. In contrast, when they are low, further stimulus can increase financial instability while inducing a fall in the risk premium. In this case, there is a trade-off between stimulating the economy and financial stability. This provides a model of the risk-taking channel of monetary policy.