In a nancial system where balance sheets are continuously marked to market, asset price changes show up immediately in changes in net worth, and elicit responses from nancial intermediaries who adjust the size of their balance sheets. We document evidence that marked-to-market leverage is strongly procyclical. Such behavior has aggregate consequences. Changes in aggregate balance sheets for intermediaries forecast changes in risk appetite in nancial markets, as measured by the innovations in the VIX index. Aggregate liquidity can be seen as the rate of change of the aggregate balance sheet of the nancial intermediaries.

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This paper presents preliminary findings and is being distributed to economists and other interested readers solely to stimulate discussion and elicit comments. The views expressed in this paper are those of the authors and are not necessarily reflective of views at the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the authors. Procyclical Leverage and Value-at-Risk

of Australia, and the Australian Prudential Regulatory Authority for valuable comments. Yian Liu provided

A widespread opinion before the credit crisis of 2007/8 was that secu-ritisation enhances nancial stability by dispersing credit risk. After the credit crisis, securitisation was blamed for allowing the \hot potato " of bad loans to be passed to unsuspecting investors. Both views miss the endo-geneity of credit supply. Securitisation enables credit expansion through higher leverage of the nancial system as a whole. Securitisation by itself may not enhance nancial stability if the imperative to expand assets drives down lending standards. The \hot potato " of bad loans sits in the nancial system on the balance sheets of large banks rather than being sold on to nal investors, since the aim of nancial intermediaries is to expand lending in order to utilise slack in balance sheet capacity. Paper presented as the Economic Journal Lecture at the Royal Economic Society Conference

2008 This Working Paper should not be reported as representing the views of the IMF. The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate. This paper uses vector autoregressions and impulse-response functions to construct a U.S. financial conditions index (FCI). Credit availability—proxied by survey results on lending standards—is an important driver of the business cycle, accounting for over 20 percent of the typical contribution of financial factors to growth. A net tightening in lending standards of 20 percentage points reduces economic activity by percent after one year and 1 percent after two years. Much of the impact of monetary policy on the economy also works through its effects on credit supply, which is evidence supporting the existence of a credit channel of monetary policy. Shocks to corporate bond yields, equity prices, and real exchange rates also contribute to fluctuations in the FCI. This FCI is an accurate predictor of real GDP growth, anticipating turning points in activity with a lead time of six to nine months.

Fluctuations in the aggregate balance sheets of …nancial intermediaries provide a window on the joint determination of asset prices and macroeconomic aggregates. We document that …nancial intermediary balance sheets contain strong predictive power for future excess returns on a broad set of equity, corporate, and Treasury bond portfolios. We also show that the same intermediary variables that predict excess returns forecast real economic activity and various measures of in‡ation. Our …ndings point to the importance of …nancing frictions in macroeconomic dynamics, and provide quantitative guidance for preemptive macroprudential and monetary policies.

Abstract We reconsider the role of financial intermediaries in monetary economics. We explore the hypothesis that financial intermediaries drive the business cycle by way of their role in determining the price of risk. In this framework, balance sheet quantities emerge as a key indicator of risk appetite and hence of the "risk-taking channel" of monetary policy. We document evidence that the balance sheets of financial intermediaries reflect the transmission of monetary policy through capital market conditions. Our findings suggest that the traditional focus on the money stock for the conduct of monetary policy may have more modern counterparts, and we suggest the importance of tracking balance sheet quantities for the conduct of monetary policy.

Les Documents de Travail reflètent les idées personnelles de leurs auteurs et n'expriment pas nécessairement la position de la Banque de France. Ce document est disponible sur le site internet de la Banque de France « www.banque-france.fr ». Working Papers reflect the opinions of the authors and do not necessarily express the views of the Banque de France. This document is available on the Banque de France Website “www.banque-france.fr”.Fuzzy Capital Requirements, Risk-Shifting and the

The paper aims at assessing the mechanics of the Great Recession, considering both its domestic propagation within the US, as well as its spillovers to advanced and emerging economies. A total of 50 countries has been investigated by means of a large-scale open economy macroeconometric model, providing an accurate assessment of the international macro/finance interface over the whole 1980-2009 period. It is found that a boom-bust credit cycle interpretation of the crisis is consistent with the empirical evidence. Moreover, concerning the real effects of the crisis within the US, stronger evidence of an asset prices channel, rather than a liquidity channel, has been detected. The results also support the effectiveness of the expansionary fiscal/monetary policy mix implemented by the Fed and the US government. Concerning the spillovers to the world economy, it is