Insights on the Greek Economy from the 3d Macro Model

Abstract

This paper examines the macroeconomic and welfare implications of banking capital requirement policies and their interactions with real and financial shocks for the Greek economy. The model employed is that of Clerc et al. (2015), a DSGE model featuring a detailed financial sector, banking capital regulations and bank default in equilibrium. The key model implication is that capital requirements reduce bank leverage and the default risk of banks but their relationship with social welfare is hump-shaped, reflecting a trade-off. The model is calibrated to data on the Greek economy and the dynamic responses to a number of financial and real shocks which may have played a material role in the unfolding of the Greek crisis are explored. The results indicate inter alia that an increase in the depositors’ cost of bank default leads to a substantial increase in the deposit rate, a decline in deposits and bank equity and an increase in bank fragility, while on the real side of the economy the decline in total credit prompts a deterioration of key macro variables. Additionally, the results imply that while recapitalizations increase bank net worth and credit supply and boost economic activity, this potential benefit is severely compromised in a high financial distress scenario, as the positive real and financial implications of a recapitalization become both smaller and more short-lived.