Working Paper: CEPR ID: DP2892
Authors: Patrick Bolton; Xavier Freixas
Abstract: This Paper analyses 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 equilibria, one of which displays all the features of a ?credit crunch?. Thus, monetary policy can also have large effects when it induces a shift between equilibria.
Keywords: corporate finance; equity; capital adequacy constraints; monetary policy
JEL Codes: E51; G30
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Tightening monetary policy (E52) | Shift from riskier to safer firms in bank lending (G21) |
| Tightening monetary policy (E52) | Credit crunch equilibrium (E51) |
| Banks' capital adequacy constraints (G21) | Restriction of bank credit availability (G21) |
| Monetary policy (E52) | Alteration of financing structure of firms (G32) |
| Market beliefs (G19) | Influence on equity raising decisions (G24) |
| Monetary policy (E52) | Feedback loop with market perceptions (D84) |