Search Frictions in Financial Markets and Monetary Policy

Search Frictions in Financial Markets and Monetary Policy,Scott Hendry

Search Frictions in Financial Markets and Monetary Policy   (Citations: 2)
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This paper introduces search frictions in nancial markets, within a standard quantita- tive monetary model, with the objective of generating greater persistence in the eects of monetary policy shocks. Specically, the paper rst assumes that banks enter into contact with suitable new entrepreneurs-clients via a search-and-matching mechanism similar to that used to study labour markets (Pissarides, 1985). Here, the interest rate on loans implements the sharing of the surplus associated with each bank-entrepreneur match. Second, we assume that the entrepreneurs, who oversee the production of the economy's output, operate a diminishing-returns-to-scale technology. In this environment, banks have an incentive to use part of any unexpected liq- uidity injection to search for new clients rather than lending it all out to its existing ones, because spreading out a given supply of funds across a wide pool of projects attenuates the eects of diminishing returns to scale. Further, these increased search eorts generate persistent changes in the relative bargaining power of banks and en- trepreneurs, which aects surplus sharing and thus the lending rate that implements it. The combination of these two eects is shown to add persistence to the decrease in nominal interest rates that follows monetary policy easings and to create hump-shaped responses in output and inflation.
Published in 2004.
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