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Financial Frictions and Monetary Transmission Strength: A Cross-Country Analysis

  • Uluc Aysun

    (University of Connecticut)

  • Ryan Brady

    (Unites States Naval Academy)

  • Adam Honig

    (Amherst College)

This paper examines the effect of financial frictions on the strength of the monetary transmission mechanism. The financial accelerator model of Bernanke, Gertler, and Gilchrist (1999) implies that the transmission mechanism of monetary policy should be stronger in countries with high levels of financial frictions. The intuition is that in these countries, external finance premiums are more sensitive to firms’ financial leverage. By affecting asset prices, therefore, monetary policy has greater impact on external finance premiums and output. We test this model’s result by estimating SVAR models on cross-country data to generate indicators for the strength of monetary transmission. We find a positive relationship between various measures of financial frictions and the strength of monetary transmission, confirming the predictions of the model.

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Paper provided by University of Connecticut, Department of Economics in its series Working papers with number 2009-24.

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Length: 53 pages
Date of creation: Aug 2009
Date of revision: Jun 2010
Handle: RePEc:uct:uconnp:2009-24
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