Financial Frictions and Monetary Transmission

Uluc Aysun (), Ryan R. Brady () and Adam Honig

No 2009-24, Working papers from University of Connecticut, Department of Economics

Abstract: This paper examines the effect of financial frictions on the strength of the credit channel of monetary policy. First, we use a DSGE model characterized by financial frictions as in Bernanke, Gertler, and Gilchrist (1999), and calibrate it using parameter values for countries with different levels of financial frictions. We find that the credit channel is stronger in countries with high levels of financial frictions. The intuition is that in these countries, external finance premiums are more sensitive to firms' financial leverage. By affecting asset prices, therefore, monetary policy has greater impact on external finance premiums and output. Second, we provide empirical evidence for this relationship. We use cross-country data in SVAR models to generate indicators for credit channel strength. We then show that there is a positive relationship between financial frictions, captured by bankruptcy recovery rates, and credit channel strength, confirming the predictions of the model.

Keywords: credit channel; financial frictions; bankruptcy costs (search for similar items in EconPapers)
JEL-codes: E44 F31 F41 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac and nep-mon
Date: 2009-08
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Persistent link: http://EconPapers.repec.org/RePEc:uct:uconnp:2009-24

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