The Credit Channel in Monetary Policy Transmission at the Zero Lower Bound. A FAVAR Approach

Editor’s note: This post is part of a series showcasing Barcelona GSE master projects by students in the Class of 2014. The project is a required component of every master program.

The Credit Channel in Monetary Policy Transmission at the Zero Lower Bound. A FAVAR Approach


Alexandru Barbu, Zymantas Budrys, Thomas Walsh

Master Program:


Paper Abstract:

This paper aims to provide a methodology for identifying the credit channel in US monetary policy transmission, consistent with periods at the zero lower bound. We follow Ciccarelli, Maddaloni and Peydro (2011) in identifying credit shocks through quarterly responses in the Federal Reserve’s Senior Loan Officer Survey, but augment their identification strategy in two key ways. First, we use the credit variables inside a Factor Augmented Vector Autoregression, to summarize the information contained in a set of 110 US macroeconomic and financial series. Second, we adopt the shadow rate developed by Wu & Xia (2013) as an alternative to the effective federal funds rate at the zero lower bound. We present our results through impulse response functions and carefully designed counterfactuals. We find that monetary policy shocks have considerably larger effects through the credit supply side than the credit demand side. Building counterfactual analyses, we find the macroeconomic effects arising from the supply side of the credit channel to be sizable. When focusing on the recent unconventional policies, our counterfactuals show only very modest movements in credit variables, suggesting that the positive effects of unconventional monetary policy during the crisis may not have acted strongly through the credit channels.

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