IMF Working Papers

Monetary Policy and Balance Sheets

Author/Editor:

Deniz O Igan ; Alain N. Kabundi ; Francisco d Nadal De Simone ; Natalia T. Tamirisa

Publication Date:

July 3, 2013

Electronic Access:

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Summary:

This paper evaluates the strength of the balance sheet channel in the U.S. monetary policy transmission mechanism over the past three decades. Using a Factor-Augmented Vector Autoregression model on an expanded data set, including sectoral balance sheet variables, we show that the balance sheets of various economic agents act as important links in the monetary policy transmission mechanism. Balance sheets of financial intermediaries, such as commercial banks, asset-backed-security issuers and, to a lesser extent, security brokers and dealers, shrink in response to monetary tightening, while money market fund assets grow. The balance sheet effects are comparable in magnitude to the traditional interest rate channel. However, their economic significance in the run-up to the recent financial crisis was small. Large increases in interest rates would have been needed to avert a rapid rise of house prices and an unsustainable expansion of mortgage credit, suggesting an important role for macroprudential policies.

Series:

Working Paper No. 2013/158

Subject:

Credit Financial crises Financial statements Housing prices Monetary policy Monetary transmission mechanism Money Prices Public financial management (PFM)