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Financial Frictions and Monetary Transmission

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Author Info
Uluc Aysun (University of Connecticut)
Ryan Brady (Unites States Naval Academy)
Adam Honig (Amherst College)

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Abstract

This paper examines the effect of financial frictions on the strength of the credit channel of monetary policy. First, we use a DSGE model characterized by financial frictions as in Bernanke, Gertler, and Gilchrist (1999), and calibrate it using parameter values for countries with different levels of financial frictions. We find that the credit channel is stronger in countries with high levels of financial frictions. The intuition is that in these countries, external finance premiums are more sensitive to firms' financial leverage. By affecting asset prices, therefore, monetary policy has greater impact on external finance premiums and output. Second, we provide empirical evidence for this relationship. We use cross-country data in SVAR models to generate indicators for credit channel strength. We then show that there is a positive relationship between financial frictions, captured by bankruptcy recovery rates, and credit channel strength, confirming the predictions of the model.

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Publisher Info
Paper provided by University of Connecticut, Department of Economics in its series Working papers with number 2009-24.

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Length: 53 pages
Date of creation: Aug 2009
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Handle: RePEc:uct:uconnp:2009-24

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Related research
Keywords: credit channel; financial frictions; bankruptcy costs;

Other versions of this item:

Find related papers by JEL classification:
E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
F31 - International Economics - - International Finance - - - Foreign Exchange
F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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