The cyclical behavior of bank price-cost margins

When price-cost margins vary endogenously in response to aggregate shocks, theirvariation becomes an additional channel through which such shocks can affect economicactivity. This was first recognized by Rotemberg and Woodford (1991 and1992) and its implications have been widely studied in goods markets. Bernanke andGertler (1989) and Bernanke, Gertler and Gilchrist (1998) study this accelerator effectin financial markets in theoretical frameworks. However, the cyclical behaviorof price-cost margins in the market for credit has been given only scant empiricalattention so far. The literature still lacks empirical evidence on this cyclicality as anecessary condition for the existence and importance of this financial accelerator. Inthis paper we attempt to start filling this gap and study the cyclical behavior of banks’price-cost margins in the United States banking sector, using time series quarterlydata for the period 1984-2005 and applying the methodology proposed by den Haan(2000) to study the comovement between variables. We find empirical evidence insupport of the countercyclicality of margins, and are able to show that it is robust tocontrolling for the effects of credit risk and the term structure of interest rates. Asa mechanism for the propagation of macroeconomic shocks, this cyclical behavior canhave important implications for both stabilization policy and RBC theory.