Federico S. Mandelman
Working Paper 2006-17b
Revised November 2009
This study shows that the presence of imperfect competition in the banking system propagates external shocks and amplifies the business cycle. Strategic limit pricing, aimed at protecting retail niches from potential competitors, generates countercyclical bank markups. Markup increments during recessions directly increase borrowing costs for firms and indirectly damage the financial position of firms' balance sheets, increasing lenders' risk perception. I use Bayesian techniques and data from Argentina to show that the inclusion of monopolistic banking improves the fit of the New Keynesian small open economy model.
JEL classification: E32, F41, G15, G21, L12
Key words: countercyclical bank markups, limit pricing, small open economies, exchange rate regimes
This paper is a revised version of part of the author's Ph.D. dissertation. He thanks his advisors Fabio Ghironi, Peter Ireland, and Fabio Schiantarelli for their invaluable guidance. Ingela Alger, Mark Bils, Luisa Lambertini, Nobuhiro Kiyotaki, Hideo Konishi, Junior Maih, Julio Rotemberg, Pedro Silos, Richard Tresch, Giancarlo Corsetti, and seminar participants at the Atlanta Fed, New York Fed, the Ninth World Congress of the Econometric Society, R@BC, Boston College, the Universidad Nacional de la Plata, the Universidad del CEMA, the University of Torcuado Di Tella, and the Universidad de San Andrés provided helpful suggestions. Nicole Baerg and M. Laurel Graefe provided superb research assistantship. Part of this work was completed while the author was visiting the Central Bank of Argentina; he gratefully acknowledges the hospitality. The views expressed here are the author's and not necessarily those of the Federal Reserve Bank of Atlanta or the Federal Reserve System. Any remaining errors are the author's responsibility.
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