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More Potent Monetary Policy? Insights from a Threshold Model

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  • Jarkko Jääskelä

    (Reserve Bank of Australia)

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    Abstract

    It has been argued that the effect of a change in the monetary policy interest rate on aggregate demand may be larger at higher levels of indebtedness through its impact on cash flows. However, the extent of credit constraints may be at least as important, if not more so. In particular, monetary policy could have a larger impact on aggregate demand when credit constraints are pervasive (which could be the case at low or high levels of indebtedness, or both). This paper examines the extent to which the strength of credit growth, which can be seen as a proxy for credit constraints, may affect the transmission of monetary policy in a way that cannot be captured in linear models. The results reveal that GDP growth is more responsive to interest rate shocks when credit growth is low. Separate models for household and business credit growth confirm this finding: consumption and business investment are more responsive to interest rate shocks when credit is growing slowly for the household and business sectors, respectively.

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    Bibliographic Info

    Paper provided by Reserve Bank of Australia in its series RBA Research Discussion Papers with number rdp2007-07.

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    Date of creation: Jul 2007
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    Handle: RePEc:rba:rbardp:rdp2007-07

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    Related research

    Keywords: monetary policy; business-cycle asymmetries; threshold models;

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