Large Banks, Loan Rate Markup and Monetary Policy

Abstract

This paper studies the implications of introducing large monopolistic banks, which can affect macroeconomic outcomes and thus the response of monetary policy to inflation, in a model with a collateral constraint linking the borrowersi?½ credit capacity to the value of their durable assets. First, we find that strategic interaction generates a countercyclical loan spread, which amplifies the impact of monetary and technology shocks on the real economy. This type of financial accelerator adds up to the one due to financial frictions and is crucially related to the existence of non-atomistic banks. Second, the level of the spread and the degree of amplification are positively related to the level of entrepreneursi?½ leverage, reflecting the fact that higher leverage implies greater elasticity of the policy rate to changes in loan rates, which in turn increases banksi?½ market power. Third, we find that amplification is stronger the more aggressive the central banki?½s response to inflation, as measured by the inflation coefficient in the Taylor rule.