Leverage Restrictions in a Business Cycle Model

Lawrence Christiano, Daisuke Ikeda

NBER Working Paper No. 18688
Issued in January 2013
NBER Program(s):   EFG

We modify an otherwise standard medium-sized DSGE model, in order to study the macroeconomic effects of placing leverage restrictions on financial intermediaries. The financial intermediaries ('bankers') in the model must exert effort in order to earn high returns for their creditors. An agency problem arises because banker effort is not observable to creditors. The consequence of this agency problem is that leverage restrictions on banks generate a very substantial welfare gain in steady state. We discuss the economics of this gain. As a way of testing the model, we explore its implications for the dynamic effects of shocks.

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An online appendix is available for this publication.

Acknowledgments and Disclosures

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