Banks, Market Organization and Macroeconomic Performance: An Agent-Based Computational Analysis1

This paper is an exploratory analysis of the role that banks play in supporting what Jevons called the mechanism of exchange. It considers a model economy in which exchange activities are facilitated and coordinated by a self-organizing network of entrepreneurial trading firms. Collectively these firms play the part of the Walrasian auctioneer, matching buyers with sellers and helping the economy to approximate equilibrium prices that no individual is able to calculate. Banks affect macroeconomic performance in this economy because their lending activities facilitate entry of trading firms and also influence their exit decisions. Both entry and exit have conflicting effects on performance, and we resort to computational analysis to understand how these conflicting effects are resolved. Our analysis suggests that banks normally improve macroeconomic performance but that when the economy is experiencing particularly bad times banks make the situation even worse. We also use the model to investigate the macro effects of bailouts, of the extent of recourse to which banks are entitled on their loans, and of various regulatory changes that have been proposed, such as restrictions on the size of banks, restrictions on loanto-value ratios, increases in capital adequacy ratios and changes that would make capital adequacy ratios vary with the state of the economy. The results suggest two kinds of regulatory changes that might improve macro performance in bad times, namely (1) a restriction on loan-to-value ratios and (2) restrictions on bank dividends.