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Agency Costs, Net Worth, and the Transmission Mechanism of Monetary Policy

Christian Fachat

No 2/2000, Bonn Econ Discussion Papers from University of Bonn, Bonn Graduate School of Economics (BGSE)

Abstract: A variety of empirical and theoretical evidence published in recent years suggests that frictions in credit markets are crucial to understand the monetary transmission mechanism. The objective of this paper is to provide a quantitative evaluation of the credit view interpretation of this evidence. Special attention is paid to the role of borrowers' net worth. A model with endogenous agency costs is developed where a debt contracting problem with asymmetric information between lender and borrower is embedded in a stochastic dynamic general equilibrium model with money. The model incorporates a cash-in-advance constraint and a limited participation assumption in order to induce a liquidity effect of monetary shocks and to propagate monetary disturbances. The paper has two principal conclusions: First, the model economy shows that a positive money supply shock generates an increase in output and in employment. Second, ex ante heterogeneity of borrowers has a significant influence on the reactions of the model economy to a monetary shock.

Keywords: financial intermediation; costly state verification; monetary transmission mechanism; credit channel; limited participation (search for similar items in EconPapers)
JEL-codes: E13 E32 E44 E51 (search for similar items in EconPapers)
Date: 2000
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