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The Connection between Wall Street and Main Street: Measurement and Implications for Monetary Policy

  • Alessandro Barattieri
  • Maya Eden
  • Dalibor Stevanovic

We propose a measure of the extent to which a financial sector is connected to the real economy. The Measure of Connectedness is the share of credit market instruments represented by claims whose direct counterpart belongs to the non-financial sectors. The aggregate U.S. Measure of Connectedness declines by about 27% in the period 1952-2009. We suggest that this increase in disconnectedness between the financial sector and the real economy may have dampened the sensitivity of the real economy to monetary shocks. We present a stylized model that illustrates how interbank trading can reduce the sensitivity of lending to the entrepreneur's net worth, thereby dampening the credit channel transmission of monetary policy. Finally, we interact our measure with both a SVAR and a FAVAR for the U.S. economy, and establish that the impulse responses to monetary policy shocks are dampened as the level of connection declines.

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Paper provided by CIRANO in its series CIRANO Working Papers with number 2013s-31.

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Length: 40 pages
Date of creation: 01 Aug 2013
Date of revision:
Handle: RePEc:cir:cirwor:2013s-31
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  1. Valentina Bruno & Hyun Song Shin, 2013. "Capital Flows and the Risk-Taking Channel of Monetary Policy," NBER Working Papers 18942, National Bureau of Economic Research, Inc.
  2. Diamond, Douglas W & Dybvig, Philip H, 1983. "Bank Runs, Deposit Insurance, and Liquidity," Journal of Political Economy, University of Chicago Press, vol. 91(3), pages 401-19, June.
  3. Francis X. Diebold & Kamil Yilmaz, 2011. "On the network topology of variance decompositions: Measuring the connectedness of financial firms," Working Papers 11-45, Federal Reserve Bank of Philadelphia.
  4. Altunbas, Yener & Gambacorta, Leonardo & Marques-Ibanez, David, 2009. "Securitisation and the bank lending channel," European Economic Review, Elsevier, vol. 53(8), pages 996-1009, November.
  5. Karen E. Dynan & Douglas W. Elmendorf & Daniel E. Sichel, 2005. "Can financial innovation help to explain the reduced volatility of economic activity?," Finance and Economics Discussion Series 2005-54, Board of Governors of the Federal Reserve System (U.S.).
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  7. Mésonnier, J-S. & Stevanovic, D., 2012. "Bank leverage shocks and the macroeconomy: a new look in a data-rich environment," Working papers 394, Banque de France.
  8. Borio, Claudio & Zhu, Haibin, 2012. "Capital regulation, risk-taking and monetary policy: A missing link in the transmission mechanism?," Journal of Financial Stability, Elsevier, vol. 8(4), pages 236-251.
  9. Philippon, Thomas & Reshef, Ariell, 2009. "Wages and Human Capital in the U.S. Financial Industry: 1909-2006," CEPR Discussion Papers 7282, C.E.P.R. Discussion Papers.
  10. Gennaioli, Nicola & Shleifer, Andrei & Vishny, Robert, 2014. "Finance and the Preservation of Wealth," CEPR Discussion Papers 9890, C.E.P.R. Discussion Papers.
  11. Bernanke, Ben & Gertler, Mark, 1995. "Inside the Black Box: The Credit Channel of Monetary Policy Transmission," Working Papers 95-15, C.V. Starr Center for Applied Economics, New York University.
  12. Diebold, Francis X. & Yilmaz, Kamil, 2012. "Better to give than to receive: Predictive directional measurement of volatility spillovers," International Journal of Forecasting, Elsevier, vol. 28(1), pages 57-66.
  13. Benjamin J. Keys & Tanmoy Mukherjee & Amit Seru & Vikrant Vig, 2010. "Did Securitization Lead to Lax Screening? Evidence from Subprime Loans," The Quarterly Journal of Economics, MIT Press, vol. 125(1), pages 307-362, February.
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