Money and Credit Shocks in Business Cycle Models with Limited Participation (PDF)

Diploma Thesis from the year 2003 in the subject Economics - Monetary theory and policy, grade: 1.5, Humboldt-University of Berlin, 72 entries in the bibliography, language: English, abstract: In business cycle theory, credit can be regarded either as enhancement mechanism for monetary policy or as source of random shocks to the economy. The current paper compares the effects of monetary shocks via the credit channel (“money shocks”) with non-monetary shocks to bank lending (“credit shocks”) by introducing them into a single benchmark model. The lending channel serves as a propagation mechanism for both type of disturbances that both come from the supply side and affect the financial sector first. The key feature of the model framework is limited participation: households have to make their portfolio decision before observing the shock. To generate a credit shock, stochastic bank capital and a capital adequacy constraint are added to the model. Each of the models can only explain some of the business cycle phenomena observed in U.S. data. In particular, the money shock model can account for the positive correlation of money, loans, and prices. The bank capital shock scenario is more approriate to replicate the countercyclical movements of prices. Both models produce a strong, short-lived liquidity effect on nominal interest rates.