Advanced Search
MyIDEAS: Login

The Impact of the FOMC's Monetary Policy Actions on the growth of Credit Risk: the Monetary Policy - Liquidity Paradox

Contents:

Author Info

  • Kwamie Dunbar

    (University of Connecticut)

Abstract

Credit risk is influenced by interest rates and market liquidity. This paper examines the direct and indirect impacts of unexpected monetary policy shifts on the growth of corporate credit risk, with the aim of quantifying the size and direction of the response. The results surprisingly indicate that monetary policy and liquidity impulses move counter to each other in their effects on credit risk ("The monetary policy-liquidity paradox"). The analysis indicates that while contractionary monetary policy creates tight money which subsequently leads to a slowing in the growth of credit risk and a reduction of liquidity in credit markets, reduced liquidity indirectly affects credit risk by accelerating its growth. The net effect of these transitory opposing forces generates the final impact on credit risk. An unexpected policy shifts is captured via a combination of the forward Fed fund rate curve and the Fed's FOMC policy announcements. Following the approach of Bernanke and Kuttner (2005), Hausman and Wongswan (2006) who examined asset prices under FOMC announcements, the study found that the estimated credit risk responses to FOMC announcements vary across credit qualities. Hence the analyses indicates that a typical unanticipated 25 basis point cut in the target fed funds rate generally resulted in an acceleration in the growth of credit risk by 0.50 percent for AAA rated corporate grade debt, and by 3.5 percent for BB rated corporate debt. Moreover, the study found a direct effect of the FOMC's policy instrument on market liquidity which had a significant effect on the growth in credit risk. The results indicate that a 1 percentage point increase in liquidity for AAA and CCC rated bonds resulted in a 0.7% and 52.45% decrease in the rate of growth in credit risk respectively.

Download Info

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
File URL: http://www.econ.uconn.edu/working/2008-05.pdf
File Function: Full text
Download Restriction: no

Bibliographic Info

Paper provided by University of Connecticut, Department of Economics in its series Working papers with number 2008-05.

as in new window
Length: 46 pages
Date of creation: Feb 2008
Date of revision:
Handle: RePEc:uct:uconnp:2008-05

Contact details of provider:
Postal: University of Connecticut 341 Mansfield Road, Unit 1063 Storrs, CT 06269-1063
Phone: (860) 486-4889
Fax: (860) 486-4463
Web page: http://www.econ.uconn.edu/
More information through EDIRC

Related research

Keywords: Credit Risk; Default Risk; Credit Default Swap; Monetary Policy; Credit Markets; Financial Markets; Vector Autoregressive Model; Federal funds rate.;

This paper has been announced in the following NEP Reports:

References

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
as in new window
  1. Ben Bernanke & Mark Gertler, 1999. "Monetary policy and asset price volatility," Economic Review, Federal Reserve Bank of Kansas City, issue Q IV, pages 17-51.
  2. Ben S. Bernanke & Kenneth N. Kuttner, 2003. "What explains the stock market's reaction to Federal Reserve policy?," Staff Reports 174, Federal Reserve Bank of New York.
  3. Rudebusch, G.D., 1996. "Do Measures of Monetary Policy in a VAR Make Sense?," Papers 269, Banca Italia - Servizio di Studi.
  4. Wongswan, Jon, 2009. "The response of global equity indexes to U.S. monetary policy announcements," Journal of International Money and Finance, Elsevier, vol. 28(2), pages 344-365, March.
  5. Wendy Edelberg & David Marshall, 1996. "Monetary policy shocks and long-term interest rates," Economic Perspectives, Federal Reserve Bank of Chicago, issue Mar, pages 2-17.
  6. William Poole & Robert H & Rasche & Daniel L. Thornton, 2002. "Market anticipations of monetary policy actions," Review, Federal Reserve Bank of St. Louis, issue Jul, pages 65-94.
  7. Kuttner, Kenneth N., 2001. "Monetary policy surprises and interest rates: Evidence from the Fed funds futures market," Journal of Monetary Economics, Elsevier, vol. 47(3), pages 523-544, June.
  8. Granger, C W J, 1969. "Investigating Causal Relations by Econometric Models and Cross-Spectral Methods," Econometrica, Econometric Society, vol. 37(3), pages 424-38, July.
  9. Evans, Charles L. & Marshall, David A., 1998. "Monetary policy and the term structure of nominal interest rates: Evidence and theory," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 49(1), pages 53-111, December.
  10. Olivier Jean Blanchard & Danny Quah, 1990. "The Dynamic Effects of Aggregate Demand and Supply Disturbances," NBER Working Papers 2737, National Bureau of Economic Research, Inc.
  11. Jon Faust & Eric Swanson & and Jonathan H. Wright, 2002. "Identifying vars based on high frequency futures data," International Finance Discussion Papers 720, Board of Governors of the Federal Reserve System (U.S.).
  12. William Poole & Robert Rasche, 2000. "Perfecting the Market's Knowledge of Monetary Policy," Journal of Financial Services Research, Springer, vol. 18(2), pages 255-298, December.
  13. Gali, J., 1992. "Variability of Durable and Nondurable Consumption: Evidence for Six O.E.C.D. Countries," Papers 92-06, Columbia - Graduate School of Business.
  14. Bernanke, Ben S & Blinder, Alan S, 1992. "The Federal Funds Rate and the Channels of Monetary Transmission," American Economic Review, American Economic Association, vol. 82(4), pages 901-21, September.
  15. Fama, Eugene F & French, Kenneth R, 1988. "Permanent and Temporary Components of Stock Prices," Journal of Political Economy, University of Chicago Press, vol. 96(2), pages 246-73, April.
  16. Don Bredin & Caroline Gavin & Gerard O Reilly, 2003. "The Influence of Domestic and International Interest Rates on the ISEQ," The Economic and Social Review, Economic and Social Studies, vol. 34(3), pages 249–265.
  17. Roberto Rigobon & Brian Sack, 2002. "The impact of monetary policy on asset prices," Finance and Economics Discussion Series 2002-4, Board of Governors of the Federal Reserve System (U.S.).
  18. Roberto Rigobon & Brian Sack, 2003. "Measuring The Reaction Of Monetary Policy To The Stock Market," The Quarterly Journal of Economics, MIT Press, vol. 118(2), pages 639-669, May.
  19. Bernanke, Ben S., 1986. "Alternative explanations of the money-income correlation," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 25(1), pages 49-99, January.
  20. Charles Evans & Kenneth Kuttner, 1998. "Can VARs describe monetary policy?," Research Paper 9812, Federal Reserve Bank of New York.
  21. Christopher A. Sims, 1986. "Are forecasting models usable for policy analysis?," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 2-16.
  22. Hakan Berument, 2005. "Measuring Monetary Policy for A Small Open Economy : Turkey," Departmental Working Papers 0509, Bilkent University, Department of Economics.
  23. Glenn D. Rudebusch, 1995. "Federal Reserve interest rate targeting, rational expectations, and the term structure," Working Papers in Applied Economic Theory 95-02, Federal Reserve Bank of San Francisco.
  24. Olivier J. Blanchard & Mark W. Watson, 1986. "Are Business Cycles All Alike?," NBER Chapters, in: The American Business Cycle: Continuity and Change, pages 123-180 National Bureau of Economic Research, Inc.
  25. Matthew D. Shapiro & Mark W. Watson, 1988. "Sources of Business Cycle Fluctuations," Cowles Foundation Discussion Papers 870, Cowles Foundation for Research in Economics, Yale University.
  26. Dungey, Mardi & Pagan, Adrian, 2000. "A Structural VAR Model of the Australian Economy," The Economic Record, The Economic Society of Australia, vol. 76(235), pages 321-42, December.
  27. Sims, Christopher A, 1980. "Macroeconomics and Reality," Econometrica, Econometric Society, vol. 48(1), pages 1-48, January.
  28. Faust Jon & Swanson Eric T & Wright Jonathan H, 2004. "Do Federal Reserve Policy Surprises Reveal Superior Information about the Economy?," The B.E. Journal of Macroeconomics, De Gruyter, vol. 4(1), pages 1-31, October.
Full references (including those not matched with items on IDEAS)

Citations

Lists

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

Statistics

Access and download statistics

Corrections

When requesting a correction, please mention this item's handle: RePEc:uct:uconnp:2008-05. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Kasey Kniffin).

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.