Credit Markets and the Propagation of Monetary Policy Shocks

provided by Research Papers in Economics

Credit Markets and the Propagation of
Monetary Policy Shocks*

Radim Bohacek^
CERGE-EI

Hugo Rodriguez Mendizabal+

Universitat Autonoma de Barcelona and centrA

January 16, 2005

Abstract

This paper analyzes the propagation of monetary policy shocks through
the creation of credit in an economy. Models of the monetary transmission
mechanism typically feature responses which last for a few quarters con-
trary to what the empirical evidence suggests. To propagate the impact
of monetary shocks over time, these models introduce adjustment costs by
which agents find it optimal to change their decisions slowly. This paper
presents another explanation that does not rely on any sort of adjustment
costs or stickiness. In our economy, agents own assets and make occupational
choices. Banks intermediate between agents demanding and supplying as-
sets. Our interpretation is based on the way banks create credit and how the
monetary authority affects the process of financial intermediation through
its monetary policy. As the central bank lowers the interest rate by buying
government bonds in exchange for reserves, high productive entrepreneurs
are able to borrow more resources from low productivity agents. We show
that this movement of capital among agents sets in motion a response of the
economy that resembles an expansionary phase of the cycle.

*We would like to thank Jim Costain, Carlos Perez Verdia and Galina Vereshchagina for very
helpful comments and suggestions. Financial support from the Spanish Ministry of Education
and Science and FEDER through grant SEC2003-00306 is gratefully acknowledged. All remaining
errors are ours.

1^CERGE-EI, Politickych veznu 7,  111 21 Prague 1, Czech Republic. Email:

[email protected]

+Departament d’Economia i Historia Economica. Edifici B. Universitat Autonoma de
Barcelona. 08193 Bellaterra Barcelona, Spain. E-mail: [email protected].

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