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Corporate finance and the monetary transmission mechanism

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Abstract

This paper analyzes the transmission mechanisms of monetary policy in a general equilibrium model of securities markets and banking with asymmetric information. Banks' optimal asset/liability policy is such that in equilibrium capital adequacy constraints are always binding. Asymmetric information about banks' net worth adds a cost to outside equity capital, which limits the extent to which banks can relax their capital constraint. In this context monetary policy does not affect bank lending through changes in bank liquidity. Rather, it has the effect of changing the aggregate composition of financing by firms. The model also produces multiple equilibria, one of which displays all the features of a "credit crunch". Thus, monetary policy can also have large effects when it induces a shift from one equilibrium to the other.

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  • Patrick Bolton & Xavier Freixas, 2000. "Corporate finance and the monetary transmission mechanism," Economics Working Papers 511, Department of Economics and Business, Universitat Pompeu Fabra.
  • Handle: RePEc:upf:upfgen:511
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    Keywords

    Asymmetric information; liabilities structure; capital regulation; monetary policy; transmission mechanism;

    JEL classification:

    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General

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