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Financial constraints and the balance sheet channel: a re-interpretation

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  • Marco Gallegati

Abstract

Aggregate demand models extending IS/LM fixed price framework yield an enhancement mechanism of the traditional monetary transmission mechanism, the credit channel, which, according to the credit view, works through the 'balance sheet channel' and the 'bank lending channel'. In this paper the augmented IS/LM model is modified assuming that investments may be financed by both internal and external sources of funds. The inclusion of internal funds in the augmented IS/LM fixed price model suggests a different interpretation of the 'balance sheet channel' as an enhancement mechanism amplifying monetary policy effects through the quantity rather than the cost of borrowing. Thus, changes in borrowers' net worth over the cycle can amplify and propagate output fluctuations directly rather than indirectly as in the traditional interpretation of the balance sheet channel. The empirical analysis of the monetary transmission mechanism for Italy in the last decade accords with the interpretation of the balance sheet channel proposed in this paper.

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  • Marco Gallegati, 2005. "Financial constraints and the balance sheet channel: a re-interpretation," Applied Economics, Taylor & Francis Journals, vol. 37(16), pages 1925-1933.
    • Handle: RePEc:taf:applec:v:37:y:2005:i:16:p:1925-1933
    DOI: 10.1080/00036840500214256
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    Cited by:

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    3. Marcello MESSORI & Alberto ZAZZARO, 2004. "Monetary profits within the circuit: Ponzi finance oer "mors tua, vita mea"?," Working Papers 200, Universita' Politecnica delle Marche (I), Dipartimento di Scienze Economiche e Sociali.
    4. Edda Claus & ris Claus, 2007. "Transmitting shocks to the economy: The contribution of interest and exchange rates and the credit channel," The Institute for International Integration Studies Discussion Paper Series iiisdp206, IIIS.
    5. Uluc Aysun & Ryan Brady & Adam Honig, 2009. "Financial Frictions and Monetary Transmission Strength: A Cross-Country Analysis," Working papers 2009-24, University of Connecticut, Department of Economics, revised Jun 2010.
    6. Elvio MATTIOLI, 2003. "The measurement of coherence in the evaluation of criteria and its effects or ranking problems illustrated using a multicriteria decision method," Working Papers 199, Universita' Politecnica delle Marche (I), Dipartimento di Scienze Economiche e Sociali.
    7. Roberto ESPOSTI & Pierpaolo PIERANI, 2005. "Price, Private Demand and Optimal Provision of Public R&D in Italian Agriculture," Working Papers 238, Universita' Politecnica delle Marche (I), Dipartimento di Scienze Economiche e Sociali.
    8. Ugo Fratesi, 2003. "Innovation Diffusion and the Evolution of Regional Disparities," ERSA conference papers ersa03p327, European Regional Science Association.
    9. Renato BALDUCCI, 2005. "Public Expenditure and Economic Growth. A critical extension of Barro's (1990) model," Working Papers 240, Universita' Politecnica delle Marche (I), Dipartimento di Scienze Economiche e Sociali.
    10. Nicola MATTEUCCI & Alessandro STERLACCHINI, 2003. "ICT and Employment Growth in Italian Industries," Working Papers 193, Universita' Politecnica delle Marche (I), Dipartimento di Scienze Economiche e Sociali.

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    JEL classification:

    • E51 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Money Supply; Credit; Money Multipliers
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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