Finance and the real economy

Abstract

This thesis studies the interaction between the financial sector and the real economy. Chapter 1 analyzes how lending cuts by banks affect firms. I identify an exogenous lending cut by a large German bank and examine the growth of firms and counties dependent on this bank. Firms directly exposed to reduced bank lending grew more slowly. On average, firms suffered when many other firms in their county experienced decreased bank lending, because of lower aggregate demand and agglomeration spillovers. The effects of the lending cut persisted after lending had resumed. Innovation and productivity fell, consistent with the persistent effects. Chapter 2 investigates the effect of house prices on household borrowing using administrative mortgage data from the UK. The chapter develops an empirical approach that exploits individual house price variation coming from the timing of refinancing events around the Great Recession. There is a clear and robust effect of house prices on borrowing. The effect can largely be explained by households using the value of their house as collateral. Chapter 3 focuses on financial institutions. How changes in bank size affect the real economy is an important question in the design of financial regulation. This chapter studies a natural experiment from postwar West Germany. Reforms by the Allied occupiers led to increases in the size of a number of banks. I estimate the effect of increased bank size on the growth of firms. The results suggest that firms did not benefit when their banks became larger. The findings are inconsistent with theories that argue the real economy benefits from increases in bank size. There is evidence that big banks are worse at processing soft information and take more risks. Big banks receive more mentions in the media, which could be an incentive for banks to become big.