Large Banks, Loan Rate Markup, and Monetary Policy

A large body of empirical evidence suggests that bank loan margins are countercyclical. We develop a model where a countercyclical spread arises due to the strategic interaction between large intermediaries-i.e., banks whose individual behavior affects macroeconomic outcomes-and the central bank. We uncover a new mechanism related to market power of banks which amplifies the impact of monetary and technology shocks on the real economy. The level of the spread is positively connected to the level of entrepreneurs' leverage, and the amplification effect is stronger the more aggressive the central bank's response to inflation.