The Balance Sheet Channel

QAU Working Paper No. QAU08-7
by Ethan Cohen-Cole and Enrique Martinez-Garcia

In this paper, we study the role of the credit channel of monetary policy in a synthesis model of the economy. Through the use of a well-specified banking sector and a regulatory capital constraint on lending, we provide an alternate mechanism that can potentially explain the periods of asymmetry in monetary policy without appealing to ad-hoc central bank preferences. This is accomplished through the characterization of the external finance premium that includes bank leverage and systemic risk.

This paper was revised in June 2009.

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