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Monetary Policy and Balance Sheets

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  • Deniz Igan
  • Alain N. Kabundi
  • Francisco Nadal-De Simone
  • Natalia T. Tamirisa

Abstract

This paper evaluates the strength of the balance sheet channel in the U.S. monetary policy transmission mechanism over the past three decades. Using a Factor-Augmented Vector Autoregression model on an expanded data set, including sectoral balance sheet variables, we show that the balance sheets of various economic agents act as important links in the monetary policy transmission mechanism. Balance sheets of financial intermediaries, such as commercial banks, asset-backed-security issuers and, to a lesser extent, security brokers and dealers, shrink in response to monetary tightening, while money market fund assets grow. The balance sheet effects are comparable in magnitude to the traditional interest rate channel. However, their economic significance in the run-up to the recent financial crisis was small. Large increases in interest rates would have been needed to avert a rapid rise of house prices and an unsustainable expansion of mortgage credit, suggesting an important role for macroprudential policies.

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Bibliographic Info

Paper provided by International Monetary Fund in its series IMF Working Papers with number 13/158.

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Length: 38
Date of creation: 03 Jul 2013
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Handle: RePEc:imf:imfwpa:13/158

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Keywords: Monetary transmission mechanism; United States; Monetary policy; Interest rates; Economic models; monetary policy transmission; balance sheets; FAVAR; generalized dynamic factor models; inflation; money stock; transmission of monetary policy; monetary policy transmission mechanism; money market; aggregate demand; government securities; monetary economics; reserve requirements; monetary shock; monetary aggregates; monetary fund; real interest rates; expansionary monetary policy; monetary base; central bank; inflation rate; loose monetary policy; macroeconomic stability; monetary conditions; monetary theory; monetary shocks;

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