Corporate Finance and the Monetary Transmission Mechanism
48 Pages Posted: 21 Nov 2000
Date Written: June 2000
This paper analyzes the transmission mechanisms of monetary policy in a general equilibrium model of securities markets and banking with asymmetric information. Banks' optimal asset/liability policy is such that in equilibrium capital adequacy constraints are always binding. Asymmetric information about banks net worth adds a cost to outside equity capital, which limits the extent to which banks can relax their capital constraint. In this context monetary policy does not affect bank lending through changes in bank liquidity. Rather, it has the effect of changing the aggregate composition of financing by firms. The model also produces multiple quilibria, one of which displays all the features of a "credit crunch". Thus, monetary policy can also have large effects when it induces a shift from one equilibrium to the other.
Keywords: monetary transmission, asymmetric information, capital constraint
JEL Classification: G32, E50
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