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Economic Theory

, Volume 52, Issue 2, pp 729–754 | Cite as

A theory of the non-neutrality of money with banking frictions and bank recapitalization

  • Zhixiong ZengEmail author
Research Article

Abstract

The unconventional monetary policy actions of the Federal Reserve during the recent Global Financial Crisis often involve implicit subsidies to banks. This paper offers a theory of the non-neutrality of money associated with capital injection into banks via nominal transfers, in an environment where banking frictions are present in the sense that there exists an agency problem between banks and their private-sector creditors. The analysis is conducted within a general equilibrium setting with two-sided financial contracting. We first show that even with perfect nominal flexibility, the recapitalization policy has real effects on the economy. We then introduce banking riskiness shocks and study optimal policy responses to such shocks.

Keywords

Bankruptcy of banks Banking riskiness shocks Two-sided debt contract Unconventional monetary policy Financial crisis 

JEL Classification

E44 E52 D82 D86 

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Copyright information

© Springer-Verlag 2011

Authors and Affiliations

  1. 1.Department of EconomicsMonash UniversityCaulfield EastAustralia

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