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Monetary policy and credit costs

Gertler, M. & Karadi, P. (2015) “Monetary policy and credit costs“, VoxEU Organisation, 10 March.


Evidence of the impact of monetary policy on economic activity supports conventional models with nominal rigidities. This column highlights the importance of the ‘credit channel’ of monetary policy. Unanticipated tightening produces a significant drop in real activity. However, monetary policy responses produce large movements in credit costs, which are due to the reaction of term premia and credit spreads. Therefore, to account for credit costs, it might be necessary to amend macroeconomic models to control for term premia and credit spreads.

How do the costs of credit react to monetary policy? This classic question is relevant not only for monetary policymakers scrutinising the impact of their policy actions, but it can also provide guidance for choosing between competing macroeconomic models. Previous evidence on the impact of monetary policy on economic activity provided convincing support to conventional models with nominal rigidities (Christiano et al. 2005). In this column we describe our recent research (Gertler and Karadi 2015), in which we find empirical support for a ‘credit channel’ of monetary policy. In particular, we find that credit costs do respond more to a monetary policy tightening than what would be justified only by higher policy rates and a fair compensation for their altered riskiness. We conclude that this finding supports models where financing frictions play a key role in explaining business cycle fluctuations. Financing frictions are relevant because, for example, without them unconventional policies such as large scale asset purchases could be completely ineffective (Curdia and Woodford 2011, Gertler and Karadi 2011).


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