Monetary Transmission and the Search for Liquidity

Victor Li ()
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Victor Li: Department of Economics, Villanova School of Business, Villanova University, https://www1.villanova.edu/university/business/faculty-and-research/faculty-by-department/biodetail.html?mail=victor.li@villanobio_long

No 19, Villanova School of Business Department of Economics and Statistics Working Paper Series from Villanova School of Business Department of Economics and Statistics

Abstract: This paper evaluates the implications of search and matching frictions in the financial market for the transmission of monetary policy. Borrowers and lenders participate in a decentralized loan market for the purpose of establishing long-term credit relationships and the provision of loanable funds to productive firms. Locating credit relationships is costly in terms of time and real resources and the interest rate is negotiated via a bargaining mechanism. This structure is incorporated into an otherwise standard monetary business cycle framework and used to study how such frictions in the credit market contribute to explaining the contemporaneous impact and propagation of monetary growth shocks and inflation. It is found that while anticipated inflation negatively impacts real activity it can also increase loan market participation and the inflow of newly established credit relationships. It is shown that while bargaining and costly search mitigate the traditional inflation tax effect of monetary injections, the existence of long term lending relations tend to dampen the immediate liquidity effects. The model also indicates that there may not necessarily exist a negative correlation between credit market tightness and aggregate activity. Furthermore, search frictions provide a potentially important mechanism for explaining the persistence of monetary shocks, an issue that has been problematic in limited participation models of the transmission mechanism.

Keywords: Firms; Search Model, Financial Market, Bargaining, Monetary Transmission (search for similar items in EconPapers)
JEL-codes: D83 D9 E0 E4 (search for similar items in EconPapers)
Date: 2012-04
New Economics Papers: this item is included in nep-cba, nep-dge and nep-mon
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Persistent link: https://EconPapers.repec.org/RePEc:vil:papers:19

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