Credit Crunch On Financial Intermediary

This paper details a speculative account of a DSGE model with housing and borrowing constrained intermediary agents where the economy is under the stain of borrower defaults on obligations to intermediaries. This economic disruption can be caused by two types of borrowers: Household or government. Borrower households use their loans as mortgages and provide their homes as collateral. Government collects taxes and borrows from banks to redistribute transfers and cover its expenditure. Both these borrower agents can default on their loans and consume or expend more. Banks which face a credit crunch have to recapitalizing to meet regulatory requirements. Recapitalizing assets propagates the shock to macroeconomic aggregates similar the Great recession. The research undertaken for this paper reveals that while alterations in fiscal policy have consequent implications for the aggregate economy, household defaults have the greatest economic impact. Similarly, when one considers welfare, the deleterious nature of household default in the economy far outweighs that of government default. The higher banking leverage ratio applied to intermediaries accounts for this discrepancy.