Credit Markets and the Propagation of Monetary Policy Shocks



borrowing activities. The lending rate is 1.39 percent per quarter while the deposit
rate is 1.30 percent.

We conduct the experiment of permanently increasing the ratio of government’s
liquid to illiquid liabilities from 0.10 to 0.11. This monetary policy change can be
achieved by an open market operation where the central bank buys government
bonds outright in exchange for reserves. Column SS2 of Table 4 shows the new
steady state corresponding to that ratio. Such a change is associated with a
larger normalized price level. It is also associated with a smaller interest rate and
inflation rate, but the changes in these variables as well as the real magnitudes are
insignificant.

Although the two steady states are very close to each other, the transition
between them is far from being negligible due to the financial constraint that some
entrepreneurs face. Notice that in both steady states, aggregate real assets are
larger than aggregate productive capital, K . In particular, entrepreneurs only use
75 percent of all real assets as capital in the first stationary equilibrium and 77
percent in the second one. As mentioned above, the difference between assets and
the capital stock used in production is a consequence of the intervention of the
government in borrowing some of the units of account created by commercial banks
and signals one of the inefficiencies of the economy. It is of no surprise that the
gap between assets and capital is reduced when the central bank proportionally
decreases the importance of its certificates of deposits. The last column of Table
4 reports the value of the corresponding ratios found in the data. We observe all
the numbers to be very close to their empirical counterpart.

Agents in this economy do not anticipate the monetary policy change. This
means that the distribution of assets across agents at the first period of the tran-
sition is equal to the one corresponding to the old steady state. Figures 2 to 7
present the transition of an economy between the two steady states. They show
transitions for each variable as the percentage change with respect to the initial
steady state (except interest rates that are presented as differences with respect
to the old steady state). In the graphs, period 0 corresponds to the old steady
state while the exogenous monetary policy change occurs on period 1. Figure 2
shows that output rises on impact by around 1.1 percent of the value of the old
steady state. This variable stays at levels between 1.1 and 1.3 percent larger than
the original stationary equilibrium for around six quarters. Then it slowly decays
towards the new steady state which is close to the old one. In the same figure we
see that both capital and labor increase over the transition. We also observe that
assets decrease over the transition monotonically. The reasons for these movements
are explained below.

Figure 3 shows that on impact, interest rates decrease by 26 basis points at an
annual rate. Notice this is the typical change the Fed usually engineers to stimulate
the US economy in recessions. At the same time, wages increase and stay above

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