This paper integrates banks into a two-sector neoclassical growth model to account for the fact that a fraction of firms relies on banks to finance their investments. There are four major contributions to the literature. First, although banks' leverage amplifies shocks, the endogenous response...

We integrate bank and bond financing into a two-sector neoclassical growth model to examine the stabilization effect of endogenous bank leverage adjustment. We show that although bank leverage amplifies shocks, the increase of leverage to a decline in bank equity is an automatic stabilizer in...