NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Financial Dampening

Johannes F. Wieland, Mu-Jeung Yang

NBER Working Paper No. 22141
Issued in March 2016
NBER Program(s):Corporate Finance, Economic Fluctuations and Growth, Monetary Economics

We propose a novel mechanism, “financial dampening,” whereby loan retrenchment by banks attenuates the effectiveness of monetary policy. The theory unifies an endogenous supply of illiquid local loans and risk-sharing among subsidiaries of bank holding companies (BHCs). We derive an IV-strategy that separates supply-driven loan retrenchment from local loan demand, by exploiting linkages through BHC-internal capital markets across spatially-separate BHC member-banks. We estimate that retrenching banks increase loan supply substantially less in response to exogenous monetary policy rate reductions. This relative decline has persistent effects on local employment and thus provides a rationale for slow recoveries from financial distress.

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Document Object Identifier (DOI): 10.3386/w22141

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