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Relationship Finance, Informed Liquidity, and Monetary Policy

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  • Araujo, Luis

    (Michigan State University, Department of Economics)

  • Minetti, Raoul

    (Michigan State University, Department of Economics)

  • Murro, Pierluigi

    (Luiss University)

Abstract

We study the aggregate effects of credit relationships in an economy where lenders’ effort in acquiring knowledge about firms’ investments endogenously depends on their financial involvement in investments. Firms trade off the benefits of precautionary internal liquidity with the need to incentivize lenders’ effort through their involvement in investment financing. We find that, through these intensive margin effects, tight credit relationships can induce suboptimally high investment levels, calling for a positive interest rate policy that departs from the Friedman rule. Loose credit relationships, however, amplify the aggregate impact of negative real shocks. Credit policies that inject liquidity into the lending sector enhance the welfare effect of credit relationships but have ambiguous effects on stabilization.

Suggested Citation

  • Araujo, Luis & Minetti, Raoul & Murro, Pierluigi, 2020. "Relationship Finance, Informed Liquidity, and Monetary Policy," Working Papers 2020-6, Michigan State University, Department of Economics.
  • Handle: RePEc:ris:msuecw:2020_006
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    More about this item

    Keywords

    Liquidity; Credit relationships; Monetary policy;
    All these keywords.

    JEL classification:

    • D02 - Microeconomics - - General - - - Institutions: Design, Formation, Operations, and Impact
    • E02 - Macroeconomics and Monetary Economics - - General - - - Institutions and the Macroeconomy
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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