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Financial Frictions and Monetary Transmission Strength: A Cross-Country Analysis

Uluc Aysun, Ryan 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 monetary transmission mechanism. The financial accelerator model of Bernanke, Gertler, and Gilchrist (1999) implies that the transmission mechanism of monetary policy should be 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. We test this model’s result by estimating SVAR models on cross-country data to generate indicators for the strength of monetary transmission. We find a positive relationship between various measures of financial frictions and the strength of monetary transmission, 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)
Pages: 53 pages
Date: 2009-08, Revised 2010-06
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac and nep-mon
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Handle: RePEc:uct:uconnp:2009-24