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The Connection between Wall Street and Main Street: Measurement and Implications for Monetary Policy

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  • Alessandro Barattieri
  • Maya Eden
  • Dalibor Stevanovic

    ()

Abstract

We propose a measure of the extent to which a financial sector is connected to the real economy. The Measure of Connectedness is the share of credit market instruments represented by claims whose direct counterpart belongs to the non-financial sectors. The aggregate U.S. Measure of Connectedness declines by about 27% in the period 1952-2009. We suggest that this increase in disconnectedness between the financial sector and the real economy may have dampened the sensitivity of the real economy to monetary shocks. We present a stylized model that illustrates how interbank trading can reduce the sensitivity of lending to the entrepreneur's net worth, thereby dampening the credit channel transmission of monetary policy. Finally, we interact our measure with both a SVAR and a FAVAR for the U.S. economy, and establish that the impulse responses to monetary policy shocks are dampened as the level of connection declines.

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Bibliographic Info

Paper provided by CIRANO in its series CIRANO Working Papers with number 2013s-31.

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Date of creation: 01 Aug 2013
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Handle: RePEc:cir:cirwor:2013s-31

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Keywords: Connection; financial sector; real economy; monetary policy transmission mechanism;

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  1. Valentina Bruno & Hyun Song Shin, 2012. "Capital Flows and the Risk-Taking Channel of Monetary Policy," BIS Working Papers 400, Bank for International Settlements.
  2. Diebold, Francis X. & Yılmaz, Kamil, 2014. "On the network topology of variance decompositions: Measuring the connectedness of financial firms," Journal of Econometrics, Elsevier, Elsevier, vol. 182(1), pages 119-134.
  3. Philippon, Thomas & Reshef, Ariell, 2009. "Wages and Human Capital in the U.S. Financial Industry: 1909-2006," CEPR Discussion Papers, C.E.P.R. Discussion Papers 7282, C.E.P.R. Discussion Papers.
  4. Borio, Claudio & Zhu, Haibin, 2012. "Capital regulation, risk-taking and monetary policy: A missing link in the transmission mechanism?," Journal of Financial Stability, Elsevier, Elsevier, vol. 8(4), pages 236-251.
  5. Altunbas, Yener & Gambacorta, Leonardo & Marques-Ibanez, David, 2009. "Securitisation and the bank lending channel," European Economic Review, Elsevier, vol. 53(8), pages 996-1009, November.
  6. Douglas W. Diamond & Philip H. Dybvig, 2000. "Bank runs, deposit insurance, and liquidity," Quarterly Review, Federal Reserve Bank of Minneapolis, Federal Reserve Bank of Minneapolis, issue Win, pages 14-23.
  7. Diebold, Francis X. & Yilmaz, Kamil, 2012. "Better to give than to receive: Predictive directional measurement of volatility spillovers," International Journal of Forecasting, Elsevier, Elsevier, vol. 28(1), pages 57-66.
  8. Bernanke, Ben & Gertler, Mark, 1995. "Inside the Black Box: The Credit Channel of Monetary Policy Transmission," Working Papers, C.V. Starr Center for Applied Economics, New York University 95-15, C.V. Starr Center for Applied Economics, New York University.
  9. Nicola Gennaioli & Andrei Shleifer & Robert W. Vishny, 2013. "Finance and the Preservation of Wealth," NBER Working Papers 19117, National Bureau of Economic Research, Inc.
  10. Jean-Stéphane Mésonnier & Dalibor Stevanovic, 2012. "Bank Leverage Shocks and the Macroeconomy: a New Look in a Data-Rich Environment," CIRANO Working Papers, CIRANO 2012s-23, CIRANO.
  11. Dynan, Karen E. & Elmendorf, Douglas W. & Sichel, Daniel E., 2006. "Can financial innovation help to explain the reduced volatility of economic activity?," Journal of Monetary Economics, Elsevier, Elsevier, vol. 53(1), pages 123-150, January.
  12. Benjamin J. Keys & Tanmoy Mukherjee & Amit Seru & Vikrant Vig, 2010. "Did Securitization Lead to Lax Screening? Evidence from Subprime Loans," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 125(1), pages 307-362, February.
  13. Thomas Philippon & Ariell Reshef, 2013. "An International Look at the Growth of Modern Finance," Journal of Economic Perspectives, American Economic Association, vol. 27(2), pages 73-96, Spring.
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