Banks and the Marginal Propensity to Lend in General Equilibrium

This paper examines the role of the marginal propensity to lend (MPL) in the transmission of monetary policy within a general equilibrium framework. To this end, I extend a standard New Keynesian DSGE model by incorporating banks. In this setting, banks face friction when substituting deposits with wholesale funding, which generates a marginal propensity to lend out of deposit shocks. Using U.S. bank-level data for calibration, I find that increasing financial frictions—raising the aggregate MPL by 66%—amplifies the responses of bank lending and investment to monetary shocks by 11% and 16%, respectively. Moreover, when the sensitivity of the marginal cost of funds also rises, loan pass-through increases by 20%, further amplifying lending and investment responses by 31% and 54%, respectively. Finally, higher MPLs amplify the production response to monetary shocks only in the medium run, through their impact on investment..