Shadow Banks and Macroeconomic Instability

We develop a macroeconomic model in which commercial banks can offload risky loans onto a ‘shadow' banking sector and financial intermediaries trade in securitized assets. We analyze the responses of aggregate activity, credit supply and credit spreads to business cycle and financial shocks. We find that interactions and spillover effects between financial institutions affect credit dynamics, that high leverage in the shadow banking system heightens the economy's vulnerability to aggregate disturbances, and that following a financial shock, a stabilization policy aimed solely at the securitization markets is relatively ineffective