Survey_FG_2016

Abstract

In our paper we develop a sequential general equilibrium model to study these issues. Bank deposits are essential to buy physical goods, and these deposits are created in the lending process by banks for firms that can only obtain funds through monitored lending. The central bank sets an interest rate (or policy rate) at which banks are able to refinance themselves and which they can earn by holding reserves at the central bank. Households sell their endowment of investment goods to firms and choose a portfolio of bank equity, bank deposits, and bonds. Consumption goods are produced by firms and sold to and consumed by households. With the proceeds, banks and firms pay dividends and reimburse bonds and loans. We consider a two-period general equilibrium model with two production sectors and one investment good. In Period t = 0, investment takes place in both sectors. In one sector, firms can obtain direct financing from the bond market and thus from households. In the second sector, firms can only be financed by bank loans. At the beginning of Period t = 1, the production technologies transform the investment good into a consumption good. The gross rates of return are impacted by a macroeconomic shock. At the end of Period t = 1, households consume the consumption good. Banks grant loans to firms in one sector, thereby creating money in the form of deposits, which serve as a means of payment and as a store of value. Households, who are initially endowed with the investment good, sell some amount of it to the latter firms in exchange for deposits enabling households to invest in bank equity and bank deposits. Households then directly provide the remaining amount of the investment good to the firms in the other sector in exchange for bonds promising the delivery of some amount of consumption good after production in the next period. The payment processes are supported by a central bank that sets the policy rate. Banks facing an outflow of deposits to other banks that is higher than the inflow— and hence net debt against other banks can refinance themselves at the policy rate. These banks can fulfill the claims of other banks by paying with central bank money. Banks that have net claims against other banks will thus receive reserves at the central bank and interest payments according to the policy rate. F