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Credit markets and the propagation of monetary policy shocks

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  • Radim Bohacek
  • Hugo Rodriguez Mendizabal

Abstract

This paper analyzes the propagation of monetary policy shocks through the creation of credit in an economy. Models of the monetary transmission mechanism typically feature responses which last for a few quarters contrary to what the empirical evidence suggests. To propagate the impact of monetary shocks over time, these models introduce adjustment costs by which agents find it optimal to change their decisions slowly. This paper presents another explanation that does not rely on any sort of adjustment costs or stickiness. In our economy, agents own assets and make occupational choices. Banks intermediate between agents demanding and supplying assets. Our interpretation is based on the way banks create credit and how the monetary authority affects the process of financial intermediation through its monetary policy. As the central bank lowers the interest rate by buying government bonds in exchange for reserves, high productive entrepreneurs are able to borrow more resources from low productivity agents. We show that this movement of capital among agents sets in motion a response of the economy that resembles an expansionary phase of the cycle.

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Bibliographic Info

Paper provided by The Center for Economic Research and Graduate Education - Economic Institute, Prague in its series CERGE-EI Working Papers with number wp244.

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Date of creation: Dec 2004
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Handle: RePEc:cer:papers:wp244

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Keywords: Credit; Monetary policy shock; Heterogeneous agents;

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  1. Thomas Cooley & Ramon Marimon & Vincenzo Quadrini, 2003. "Aggregate Consequences of Limited Contract Enforceability," NBER Working Papers 10132, National Bureau of Economic Research, Inc.
  2. Bernanke, B. & Gertler, M. & Gilchrist, S., 1998. "The Financial Accelerator in a Quantitative Business Cycle Framework," Working Papers, C.V. Starr Center for Applied Economics, New York University 98-03, C.V. Starr Center for Applied Economics, New York University.
  3. Timothy S. Fuerst, 1994. "Monetary and financial interaction in the business cycle," Proceedings, Federal Reserve Bank of Cleveland, Federal Reserve Bank of Cleveland, pages 1321-1353.
  4. Vincenzo Quadrini, 1997. "Entrepreneurship, saving and social mobility," Discussion Paper / Institute for Empirical Macroeconomics, Federal Reserve Bank of Minneapolis 116, Federal Reserve Bank of Minneapolis.
  5. Jean-François Fagnart & Omar Licandro & Franck Portier, 1999. "Firm Heterogeneity, Capacity Utilization and the Business Cycle," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 2(2), pages 433-455, April.
  6. Fabio Canova & Joaquim Pires Pina, 1998. "Monetary policy misspecification in VAR models," Economics Working Papers, Department of Economics and Business, Universitat Pompeu Fabra 420, Department of Economics and Business, Universitat Pompeu Fabra, revised Sep 1999.
  7. Lucas, Robert E, Jr, 1980. "Equilibrium in a Pure Currency Economy," Economic Inquiry, Western Economic Association International, Western Economic Association International, vol. 18(2), pages 203-20, April.
  8. Lawrence J. Christiano & Martin Eichenbaum & Charles Evans, 1994. "The effects of monetary policy shocks: evidence from the Flow of Funds," Working Paper Series, Macroeconomic Issues, Federal Reserve Bank of Chicago 94-2, Federal Reserve Bank of Chicago.
  9. Pedro Pablo Álvarez Lois, 2003. "Capacity utilization and Monetary Policy," Banco de Espa�a Working Papers, Banco de Espa�a 0306, Banco de Espa�a.
  10. Thomas Cooley & Vincenzo Quadrini, 2006. "Monetary policy and the financial decisions of firms," Economic Theory, Springer, Springer, vol. 27(1), pages 243-270, 01.
  11. Carlstrom, Charles T & Fuerst, Timothy S, 1997. "Agency Costs, Net Worth, and Business Fluctuations: A Computable General Equilibrium Analysis," American Economic Review, American Economic Association, American Economic Association, vol. 87(5), pages 893-910, December.
  12. R. Glenn Hubbard, 1994. "Is There a `Credit Channel' for Monetary Policy?," NBER Working Papers 4977, National Bureau of Economic Research, Inc.
  13. R. Glenn Hubbard, 1995. "Is there a "credit channel" for monetary policy?," Proceedings, Federal Reserve Bank of St. Louis, Federal Reserve Bank of St. Louis, issue May, pages 63-77.
  14. Bernanke, Ben & Gertler, Mark, 1989. "Agency Costs, Net Worth, and Business Fluctuations," American Economic Review, American Economic Association, American Economic Association, vol. 79(1), pages 14-31, March.
  15. R. Glenn Hubbard, 1995. "Is there a "credit channel" for monetary policy?," Review, Federal Reserve Bank of St. Louis, Federal Reserve Bank of St. Louis, issue May, pages 63-77.
  16. Alexander Monge Naranjo, 2000. "Financial Markets, Creation and Liquidation of Firms and Aggregate Dynamics," Econometric Society World Congress 2000 Contributed Papers, Econometric Society 1648, Econometric Society.
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Cited by:
  1. Patrick A. Pintus & Yi Wen, 2010. "Leveraged borrowing and boom-bust cycles," Working Papers, Federal Reserve Bank of St. Louis 2010-027, Federal Reserve Bank of St. Louis.
  2. Victor E. Li, 2012. "Monetary Transmission and the Search for Liquidity," Villanova School of Business Department of Economics and Statistics Working Paper Series, Villanova School of Business Department of Economics and Statistics 19, Villanova School of Business Department of Economics and Statistics.
  3. Piti Disyatat, 2008. "Monetary policy implementation: Misconceptions and their consequences," BIS Working Papers 269, Bank for International Settlements.

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