The financial accelerator and marketable debt: the prolongation channel
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Michael Kühl
Abstract
This paper investigates the effects of mark-to-market accounting for risky liabilities on the business cycle. While marking assets to market results in an amplification of the business cycle, as is well-known from the financial accelerator model à la Bernanke, Gertler, and Gilchrist [Bernanke, B. S., M. Gertler, and S. Gilchrist. 1999. “The Financial Accelerator in a Quantitative Business Cycle Framework.” In Handbook of Macroeconomics, edited by J. Taylor and M. Woodford, Elsevier.], allowing for debt with a specific maturity priced at market value generates ambiguous effects. Changes in the market price of debt affects firms’ net worth since the accounting principle takes the perspective of repurchasing debt. This is called the prolongation channel of debt. Real economic activity is attenuated as long as asset and debt prices move in the same direction, whereas the response of debt prices is stronger. This happens for a monetary policy shock or a shock to total factor productivity. Amplification occurs if both prices move in opposite directions, as is the case for a demand shock. The implications for the business cycle eventually depend on the occurrence of shocks. Implementing mark-to-market accounting for liabilities in a model for the US yields a higher volatility of the business cycle.
Acknowledgments
I would like to thank Josef Hollmayr, Stéphane Moyen, participants of a Bundesbank research seminar, participants of the 2015 Annual Conference of the Royal Economic Society and an anonymous referee for helpful comments. The paper represents the author’s personal opinions and does not necessarily reflect the official views or policies of the Deutsche Bundesbank.
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- Contributions
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- The macroeconomic impact of shocks to bank capital buffers in the Euro Area
- The effects of monetary policy on input inventories
- The welfare effects of infrastructure investment in a heterogeneous agents economy
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