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Financial Cycles with Heterogeneous Intermediaries

Review of Economic Studies 2024 91(2), 817-857 open access
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.