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Financial frictions and the strength of monetary transmission

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  • Aysun, Uluc
  • Brady, Ryan
  • Honig, Adam

Abstract

This paper examines the effect of financial frictions on the strength of the monetary transmission mechanism. Credit channel theory implies that the transmission mechanism of monetary policy should be stronger in countries with high levels of financial frictions, all else equal. 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 theoretical prediction 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, supporting the predictions of credit channel theory.

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  • Aysun, Uluc & Brady, Ryan & Honig, Adam, 2013. "Financial frictions and the strength of monetary transmission," Journal of International Money and Finance, Elsevier, vol. 32(C), pages 1097-1119.
    • Handle: RePEc:eee:jimfin:v:32:y:2013:i:c:p:1097-1119
    DOI: 10.1016/j.jimonfin.2012.09.003
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    More about this item

    Keywords

    Monetary transmission; Financial frictions; Bankruptcy costs;
    All these keywords.

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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