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Financial Frictions and Credit Spreads

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  • Ke Pang

    ()

  • Pierre L. Siklos

    ()

Abstract

This paper uses the credit-friction model developed by C´urdia and Woodford, in a series of papers, as the basis for attempting to mimic the behavior of credit spreads in moderate as well as in times of crisis. We are able to generate movements in representative credit spreads that are, at times, both sharp and volatile. We then study the impact of quantitative easing and credit easing. Credit easing is found to reduce spreads unlike quantitative easing which has opposite effects. The relative advantage of credit easing becomes even clearer when we allow borrowers to default on their loans. Since increases in default offset the beneficial effects of credit easing on spreads, the policy implication is that, in times of financial stress, the central bank should be aggressive when applying credit easing policies.

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Bibliographic Info

Paper provided by Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University in its series CAMA Working Papers with number 2010-28.

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Length: 39 pages
Date of creation: Oct 2010
Date of revision:
Handle: RePEc:een:camaaa:2010-28

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