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Watering a lemon tree: heterogeneous risk taking and monetary policy transmission
We build a general equilibrium model with maturity transformation that impedes monetary policy transmission. In equilibrium, productive agents choose higher leverage, exposing themselves to greater liquidity risk, which limits their responsiveness to interest rate changes. A reduction in the interest rate then leads to a deterioration in aggregate investment quality, which blunts the monetary stimulus and decreases liquidation values. This, in turn, reduces loan demand, decreasing the interest rate further and generating a negative spiral. Overall, the allocation of credit is distorted and monetary stimulus can become ineffective even with significant interest rate drops.
Cite this item
Dong Beom Choi & Thomas M. Eisenbach & Tanju Yorulmazer, Watering a lemon tree: heterogeneous risk taking and monetary policy transmission, Federal Reserve Bank of New York, Staff Reports 724, 01 Apr 2015, revised 01 Nov 2017.
- E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
- E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
- G20 - Financial Economics - - Financial Institutions and Services - - - General
Keywords: monetary policy transmission; financial frictions; heterogeneous agents; financial intermediation
This item with handle RePEc:fip:fednsr:724
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