Business Cycles and Monetary Regimes in Emerging Economies: A Role for a Monopolistic Banking Sector
Federal Reserve Bank of Atlanta Working Paper No. 2006-17a
64 Pages Posted: 26 Nov 2006 Last revised: 6 Jul 2014
Date Written: August 2009
Abstract
Starting from a variant of the New Keynesian model for a small open economy, I extend the standard credit channel framework to show that the presence of imperfect competition in the banking system propagates external shocks and amplifies the business cycle. This novel modeling of the banking system captures various well-documented facts in developing economies. I show that strategic limit pricing, aimed at protecting retail niches from potential competitors, generates countercyclical bank markups. Markup increments, as a consequence of sudden capital outflows, end up increasing borrowing costs for firms as well as damaging the financial position of firms' balance sheets. The recognition of monopoly power in banking allows the model to account for the relatively high investment volatility registered in emerging countries, even in the presence of debt that is fully denominated in local currency and flexible exchange rates.
Keywords: countercyclical bank markups, limit pricing, small open economies, exchange rate regimes
JEL Classification: E32, F41, G15, G21, L12
Suggested Citation: Suggested Citation
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