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RFS Advance Access originally published online on May 15, 2006
Review of Financial Studies 2006 19(3):829-870; doi:10.1093/rfs/hhl002
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Right arrow E52 - Monetary Policy (Targets, Instruments, and Effects)
Right arrow G12 - Asset Pricing
Right arrow G21 - Banks; Other Depository Institutions; Mortgages
Right arrow G32 - Financing Policy; Capital and Ownership Structure
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© The Author 2006. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For permissions, please email: journals.permissions@oxfordjournals.org.

Corporate Finance and the Monetary Transmission Mechanism

Patrick Bolton
Columbia University

Xavier Freixas
Universitat Pompeu Fabra

Address correspondence to Patrick Bolton, Columbia University, 3022 Broadway, Uris Hall Room 804, New York, NY 10027, or e-mail: pb2208{at}columbia.edu.

We analyze the transmission effects of monetary policy in a general equilibrium model of the financial sector, with bank lending and securities markets. Bank lending is constrained by capital adequacy requirements, and asymmetric information adds a cost to outside bank equity capital. In our model, monetary policy does not affect bank lending through changes in bank liquidity; rather, it operates through changes in the spread of bank loans over corporate bonds, which induce changes in the aggregate composition of financing by firms, and in banks’ equity-capital base. The model produces multiple equilibria, one of which displays all the features of a "credit crunch."


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