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Lending Relationships and Monetary Policy

  • Henrique S. Basso and Javier Coto-Martinez, Yunus Aksoy,

    ()

    (yak-soy@ems.bbk.ac.uk, javier.martinez@brunel.ac.uk)

Financial intermediation and bank spreads are important elements in the analysis of business cycle transmission and monetary policy. We present a simple framework that introduces lending relationships, a relevant feature of financial intermediation that has been so far neglected in the monetary economics literature, into a dynamic stochastic general equilibrium model with staggered prices and cost channels. Our main findings are: (i) banking spreads move countercyclically generating amplified output responses, (ii) spread movements are important for monetary policy making even when a standard Taylor rule is employed (iii) modifying the policy rule to include a banking spread adjustment improves stabilization of shocks and increases welfare when compared to rules that only respond to output gap and inflation, and finally (iv) the presence of strong lending relationships in the banking sector can lead to indeterminacy of equilibrium forcing the central bank to react to spread movements.

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Paper provided by Uppsala University, Department of Economics in its series Working Paper Series with number 2009:18.

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Length: 42 pages
Date of creation: 21 Jan 2010
Date of revision: 21 Jan 2010
Handle: RePEc:hhs:uunewp:2009_018
Contact details of provider: Postal: Department of Economics, Uppsala University, P. O. Box 513, SE-751 20 Uppsala, Sweden
Phone: + 46 18 471 25 00
Fax: + 46 18 471 14 78
Web page: http://www.nek.uu.se/
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