Sunday, October 11, 2009: 12:55 PM
This paper shows that the credit channel of monetary policy is stronger in countries that have low levels of institutional quality. We reach this conclusion in two ways. First, we simulate a DSGE model characterized by financial frictions as in Bernanke Gertler and Gilchrist (1999) by calibrating this model to data from countries with different institutional qualities. Second, we use cross country data in a SVAR model to generate an indicator for monetary policy strength. We include this variable in a second stage regression to investigate the relationship between credit channel strength and various proxies for institutional quality. Our findings imply that in countries with low institutional quality, firms’ financial leverage has a greater impact on external finance premiums, and that monetary policy, through its effects on asset prices, has greater leverage in these countries.