Banking Networks and Economic Growth: From Idiosyncratic Shocks to Aggregate Fluctuations

100 Pages Posted: 4 Jun 2020 Last revised: 24 May 2021

See all articles by Shohini Kundu

Shohini Kundu

University of California, Los Angeles (UCLA) - Anderson School of Management; Centre for Economic Policy Research (CEPR)

Nishant Vats

Washington University in Saint Louis, John M. Olin Business School

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Date Written: April 25, 2020

Abstract

The objective of this paper is to explore the transmission of non-capital shocks through banking networks. We develop a methodology to construct non-capital (real) shocks, idiosyncratic shocks, using labor productivity shocks to large firms. We document a change in the relationship between (foreign) idiosyncratic shocks in state j and (domestic) economic growth in state i between 1978 and 2000 wherein the relation changes from positive to negative over this period. We show that the contemporaneous changes in banking integration across states is a key driver of this phenomenon. This is driven by geographically diversified banks diverting funds away from economies experiencing negative shocks towards other unaffected economies. This result operates through changes in bank loan supply. Our instrumental variable estimates suggest that a 1% increase in the bank loan supply is associated with a 0.05-0.26 pp increase in economic growth. Lastly, we argue that this mechanism can explain the decrease in covariance of state-level fluctuations, potentially explaining the Great Moderation, the period of relatively low aggregate volatility.

JEL Classification: E32, E44, F36, G21, G28, O47, R11, R12

Suggested Citation

Kundu, Shohini and Vats, Nishant, Banking Networks and Economic Growth: From Idiosyncratic Shocks to Aggregate Fluctuations (April 25, 2020). Available at SSRN: https://ssrn.com/abstract=3556299 or http://dx.doi.org/10.2139/ssrn.3556299

Shohini Kundu

University of California, Los Angeles (UCLA) - Anderson School of Management ( email )

110 Westwood Plaza
Los Angeles, CA 90095-1481
United States

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Nishant Vats (Contact Author)

Washington University in Saint Louis, John M. Olin Business School ( email )

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