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Corporate finance and the monetary transmission mechanism

Bolton, Patrick; Freixas, Xavier

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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Business
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December 21, 2010

Notes

March 4, 2006. Review of Financial Studies, vol. 19, no. 3 (2006), pp. 829-870.