Learning about banks’ net worth and the slow recovery after the financial crisis

Abstract

We examine the influence of information rigidities about the net worth of banks on the real economy over time. In a first part, we show empirically that expectations about the net earnings of banks (as a proxy for the growth of net worth) are biased, particularly during the financial crisis. Investors display a learning behavior in forming expectations about future bank earnings during the crisis. In a second part, by drawing on a New Keynesian general equilibrium model with a banking sector, we demonstrate that, by quantitatively incorporating this type of information updating and expectations formation about the net worth of banks, noisy information is able to produce a slow recovery in the aftermath of the financial crisis and match the data more closely than in the full information rational expectation (FIRE) case.