A descriptive model of banking and aggregate demand

We integrate a banking sector into an accessible macroeconomic framework, which then provides new explanations for developments around the Global Financial Crisis. The analysis shows that growth of banking sector money supply may explain the secular decline in long-term interest rates before the crisis. A new bank funding channel of monetary transmission clarifies why even large increases in central bank policy rates could not reverse this trend. Our analysis challenges the view that monetary policy becomes ineffective in a liquidity trap, and shows that bank recapitalizations are more effective than fiscal expansions in restoring aggregate demand after a banking crisis.
  
Keywords: banking, aggregate demand, monetary transmission, global financial crisis.
JEL classifications: E32, E50, E63, G01, G21, G28.

Working paper no. 500.