Business Cycles and the Role of Imperfect Competition in the Banking System

Authors


  • *This paper is a revised version of part of my PhD dissertation. I thank my advisors Fabio Ghironi, Peter Ireland and Fabio Schiantarelli for their invaluable guidance. Ingela Alger, Mark Bils, Stephen Bond, Luisa Lambertini, Nobuhiro Kiyotaki, Hideo Konishi, Todd Prono, Julio Rotemberg, Richard Tresch, Benn Steil (the editor), two anonymous referees and seminar participants at the Atlanta Fed, New York Fed, Ninth World Congress of the Econometric Society, Boston College, U. de la Plata, UCEMA, U. T. Di Tella, U. de San Andrés provided helpful suggestions. M. Laurel Graefe provided superb research assistantship. Beyond the usual disclaimer, I must note that any views expressed herein are those of the author and not necessarily those of the Federal Reserve Bank of Atlanta or the Federal Reserve System.

Federico S. Mandelman
Research Economist and Assistant Policy Adviser
Research Department
Federal Reserve Bank of Atlanta
1000 Peachtree Street N.E.
Atlanta
Georgia 30309-4470
federico.mandelman@atl.frb.org

Abstract

This study shows that the entry of new competitors in the banking system tends to occur during economic expansions. In addition, it provides evidence that established banks react by lowering the interest rates that borrowers pay, thus reducing bank system profits. In contrast, banks are able to sustain higher bank profit margins during recessions. These findings suggest that this pricing strategy is aimed at deterring the entry of new bank competitors into highly segmented regional retail niches. Consequently, monopolistic banking not only creates an inefficient wedge between lenders and borrowers but, as credit becomes cheaper in booms and more expensive during recessions, it further contributes to macroeconomic volatility. Empirical evidence for 124 countries and a general equilibrium model suitable to quantify the welfare losses of this monopolistic framework are provided.

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