Credit Markets and the Propagation of Monetary Policy Shocks

However, the process of intermediation makes some of these assets to remain idle.
This is due to the government and the central bank using some of these units of
account. We interpret the ratio of productive capital to real assets as capacity
utilization. Furthermore, the central bank in our model has the ability to affect
the proportion of assets employed as capital by changing the amount of units of
accounts used in the financial sector. Monetary policy is conducted by buying
and selling government bonds in exchange for reserves which commercial banks
need in order to intermediate between borrowers and lenders. In this way, we
deviate from standard macro models that assume central banks to directly control
broad monetary aggregates. Instead, we distinguish between narrow and broad
definitions of money and incorporate a more realistic implementation of monetary
policy through the use of open market operations. We show this addition has
important implications for the neutrality of money.

3 the model

The model is a nominal version of Bohacek [5]. In this economy there is a con-
tinuum of agents with mass one. These individuals may differ in the amount of
accumulated assets and in their productivities. Each agent has access to a decision
on whether to allocate his talent to an entrepreneurial activity or to use it as a
worker. There is also a corporate banking sector in the business of intermediating
between agents with an excess of funds and agents with liquidity needs. Finally,
there is a central bank that designs monetary policy.

Each agent is endowed with a unit of time and evaluates streams of consumption
(ct) with the utility function

∞

^Xβ^tu (ct)
t=0

where β ∈ (0, 1) and u : <+ → < is a bounded, strictly increasing, strictly concave,
and twice differentiable continuous function that satisfies the Inada conditions. At
the beginning of every period, agents are identified by a level of accumulated assets
a ∈ A = [0, ∞) and by an idiosyncratic productivity shock z ∈ Z = [z, z]. This
productivity level is carried from the previous period and represents a signal for
the effective productivity the agent will have later in the period when production
takes place, z⁰ ∈ Z .

The timing of events is as follows. First, the central bank decides on the mon-
etary policy stance defined as the composition of government liabilities. Second,
agents make an occupational choice and decide whether to be a worker or an en-
trepreneur. Workers deposit their assets at the financial intermediaries and offer

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