Aggregate Implications of Financial Heterogeneity to the Bank-Lending Channel in Monetary Union
48 Pages Posted: 27 Jan 2021 Last revised: 18 Apr 2021
Date Written: November 22, 2020
In this study, I investigate the impact of heterogeneity in financial frictions across the Eurozone on credit supply dynamics and the effectiveness of bank-lending channel of monetary policy, by integrating empirical and quantitative analysis. Using country-level bank balance sheet data, I estimate financial frictions in the credit supply curve in a two-country, monetary union New Keynesian model with banks. The results indicate that financial frictions in core countries are significantly smaller than peripheral countries. Given this financial heterogeneity, my model predicts that firstly, financial shocks cause more severe recessions in peripheral countries than in core countries. Secondly, the bank-lending channel has a weaker stimulus effect in peripheral countries under the single interest rates policy. Moreover, I find that asset purchase policies, particularly region-specific asset purchases, can curtail the differences in transmission of the bank-lending channel inside a region.
Keywords: financial friction; the Eurozone; monetary union; financial heterogeneity; bank-lending channel
JEL Classification: E44, E52, F45, G21
Suggested Citation: Suggested Citation