The Federal Reserve Bank of New York works to promote sound and well-functioning financial systems and markets through its provision of industry and payment services, advancement of infrastructure reform in key markets and training and educational support to international institutions.
The Outreach & Education function engages, empowers and educates the public in the Second District. Our outreach mission furthers the Bank’s commitment to the region by listening to the communities we serve and developing programs, analysis and sponsored conferences and clinics to help meet their needs. Our education mission aims to advance public knowledge about the Federal Reserve System and its role in the economy.
We present a theory of financial intermediary leverage cycles within a dynamic model of the macroeconomy. Intermediaries face risk-based funding constraints that give rise to procyclical leverage and a procyclical share of intermediated credit. The pricing of risk varies as a function of intermediary leverage, and asset return exposures to intermediary leverage shocks earn a positive risk premium. Relative to an economy with constant leverage, financial intermediaries generate higher consumption growth and lower consumption volatility in normal times, at the cost of endogenous systemic financial risk. The severity of systemic crisis depends on two state variables: intermediaries’ leverage and net worth. Regulations that tighten funding constraints affect the systemic risk-return tradeoff by lowering the likelihood of systemic crises at the cost of higher pricing of risk.