Working Paper

Lending Relationships and Optimal Monetary Policy


Abstract: We construct and calibrate a monetary model of corporate finance with endogenous formation of lending relationships. The equilibrium features money demands by firms that depend on their access to credit and a pecking order of financing means. We describe the mechanism through which monetary policy affects the creation of relationships and firms' incentives to use internal or external finance. We study optimal monetary policy following an unanticipated destruction of relationships under different commitment assumptions. The Ramsey solution uses forward guidance to expedite creation of new relationships by committing to raise the user cost of cash gradually above its long-run value. Absent commitment, the user cost is kept low, delaying recovery.

Keywords: Credit relationships; banks; corporate finance; optimal monetary policy;

JEL Classification: D83; E32; E51;

https://doi.org/10.21144/wp20-13

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Bibliographic Information

Provider: Federal Reserve Bank of Richmond

Part of Series: Working Paper

Publication Date: 2020-09-25

Number: 20-13

Note: This revised version: May 2020