A theory of the non-neutrality of money with banking frictions and bank recapitalization

Zeng, Zhixiong (2011): A theory of the non-neutrality of money with banking frictions and bank recapitalization. Forthcoming in: Economic Theory

Abstract

The unconventional monetary policy actions of the Federal Reserve during the recent Global Financial Crisis often involve implicit subsidies to banks. This paper offers a theory of the non-neutrality of money associated with capital injection into banks via nominal transfers, in an environment where banking frictions are present in the sense that there exists an agency problem between banks and their private-sector creditors. The analysis is conducted within a general equilibrium setting with two-sided financial contracting. We first show that even with perfect nominal flexibility, the recapitalization policy has real effects on the economy. We then introduce banking riskiness shocks and study optimal policy responses to such shocks.

• Item Type: MPRA Paper
• Language: English
• Keywords: Bankruptcy of banks; banking riskiness shocks; two-sided debt contract; unconventional monetary policy; financial crisis
• Subjects: D - Microeconomics > D8 - Information, Knowledge, and Uncertainty > D86 - Economics of Contract: Theory; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E52 - Monetary Policy; E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E44 - Financial Markets and the Macroeconomy; D - Microeconomics > D8 - Information, Knowledge, and Uncertainty > D82 - Asymmetric and Private Information ; Mechanism Design

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Zeng, Z.: A Theory of the non-neutrality of money with banking frictions and bank recapitalization. Working paper (2010)