Market power in banking, countercyclical margins and the international transmission of business cycles

By introducing an imperfectly competitive banking sector into a standard two-country, two-good RBC model with complete asset markets, we study the international transmission of aggregate TFP shocks in an environment with noncompetitive financial intermediation In this model, price-cost margins in a global loan market are endogenous and countercyclical As a result, a positive TIT shock in one country spills over to another through a reduction in the global cost of both credit and externally financed investment The quantitative analysis shows that countercyclical margins on loans play a key role in bringing the predictions of the theory closer to the observed cross-country cyclical co-movements of consumption, employment, investment and output Recessions are deeper when the cost of credit rises during these economic downturns Thus, a financial accelerator arises in our framework, unveiling the increased importance of stabilization policies in economies where margins in credit markets are countercyclical (C) 2009 Elsevier B V All rights reserved