Monetary Transmission and the Search for Liquidity
AbstractThis paper evaluates the implications of search and matching frictions in the financial market for the transmission of monetary policy. Borrowers and lenders participate in a decentralized loan market for the purpose of establishing long-term credit relationships and the provision of loanable funds to productive firms. Locating credit relationships is costly in terms of time and real resources and the interest rate is negotiated via a bargaining mechanism. This structure is incorporated into an otherwise standard monetary business cycle framework and used to study how such frictions in the credit market contribute to explaining the contemporaneous impact and propagation of monetary growth shocks and inflation. It is found that while anticipated inflation negatively impacts real activity it can also increase loan market participation and the inflow of newly established credit relationships. It is shown that while bargaining and costly search mitigate the traditional inflation tax effect of monetary injections, the existence of long term lending relations tend to dampen the immediate liquidity effects. The model also indicates that there may not necessarily exist a negative correlation between credit market tightness and aggregate activity. Furthermore, search frictions provide a potentially important mechanism for explaining the persistence of monetary shocks, an issue that has been problematic in limited participation models of the transmission mechanism.
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Bibliographic InfoPaper provided by Villanova School of Business Department of Economics and Statistics in its series Villanova School of Business Department of Economics and Statistics Working Paper Series with number 19.
Date of creation: Apr 2012
Date of revision:
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Web page: http://www.villanova.edu/business/facultyareas/economics/
More information through EDIRC
Firms; Search Model; Financial Market; Bargaining; Monetary Transmission;
Find related papers by JEL classification:
- D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search, Learning, and Information
- D9 - Microeconomics - - Intertemporal Choice
- E0 - Macroeconomics and Monetary Economics - - General
- E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
This paper has been announced in the following NEP Reports:
- NEP-ALL-2012-05-08 (All new papers)
- NEP-CBA-2012-05-08 (Central Banking)
- NEP-DGE-2012-05-08 (Dynamic General Equilibrium)
- NEP-MON-2012-05-08 (Monetary Economics)
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