Lending Relationships and Monetary Policy

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

http://d.repec.org/n?u=RePEc:bbk:bbkefp:0912&r=dge

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.

There has been relatively little work on lending relationships, primarily because it is a very hard problem to model and solve. Here is a fresh attempt that seems rather successful.

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2 Responses to Lending Relationships and Monetary Policy

  1. This paper uses Calvo pricing! What an abomination, especially given the research question! You cannot study the impact of monetary policy when, whatever the monetary stance, the same proportion of firms is adjusting prices.

    This has nothing to do with General Equilibrium…

  2. Agent Continuum says:

    The Economic Logician is right!

    Also, rather than tweaking the Taylor rule, it would have been interesting to see how this mechanism works under discretion.

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