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Corporate finance and the monetary transmission mechanism

Patrick Bolton; Xavier Freixas

Title:
Corporate finance and the monetary transmission mechanism
Author(s):
Bolton, Patrick
Freixas, Xavier
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Articles
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Notes:
Review of Financial Studies, vol. 19, no. 3 (2006), pp. 829-870.
March 4, 2006.
Abstract:
We analyze the transmission effects of monetary policy in a general equilibrium model of the financial sector, with bank lending and securities markets. Bank lending is constrained by capital adequacy requirements, and asymmetric information adds a cost to outside bank equity capital. In our model, monetary policy does not affect bank lending through changes in bank liquidity; rather, it operates through changes in the spread of bank loans over corporate bonds, which induce changes in the aggregate composition of financing by firms, and in banks’ equity-capital base. The model produces multiple equilibria, one of which displays all the features of a "credit crunch."
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