Financial Development and the Asymmetry of Monetary Policy
30 Pages Posted: 11 Apr 2006
Date Written: April 3, 2006
In this paper we develop a simple model of the relationship between financial market development and investment by entrepreneurs in the presence of a Central Bank. The model analyzes how the level of financial development affects the way credit spreads, and therefore the volume of credit and output, react to monetary policy actions. We show that in countries where financial markets are poorly developed, lending rates may react in an asymmetric manner to monetary expansions and contractions; i.e. monetary contractions generate a larger impact on credit than expansions. Other implications of the model are in line with those in the literature. Cross-country empirical evidence for this asymmetry is obtained from a large panel dataset.
Keywords: Financial Markets, Investment, Asymmetry of Response of Credit, Lending Rates
JEL Classification: E44, E52
Suggested Citation: Suggested Citation