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Financial Frictions and Monetary Policy

In: Money: Theory and Practice

Author

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  • Jin Cao

    (Norges Bank)

  • Gerhard Illing

    (LMU Munich)

Abstract

This chapter reviews models focusing on the role of financial sector, in particular on banks for the monetary transmission mechanism. Financial frictions prevent banks from allocating credit to those agents needing it most, and induce banks to overreact to macroeconomic shocks, increasing volatilities in output. This chapter characterizes conditions under which monetary policy can help to dampen the distortions arising from financial frictions, improving social welfare. This chapter focuses on financial frictions that impede the transmission of monetary policy to the real economy; in particular, four types of financial frictions are discussed: incomplete market, principal–agent problems, maturity mismatch, and leverage cycle.

Suggested Citation

  • Jin Cao & Gerhard Illing, 2019. "Financial Frictions and Monetary Policy," Springer Texts in Business and Economics, in: Money: Theory and Practice, chapter 9, pages 281-355, Springer.
    • Handle: RePEc:spr:sptchp:978-3-030-19697-4_9
    DOI: 10.1007/978-3-030-19697-4_9
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