The Balance Sheet Channel

Abstract

In this paper, we study the role of the credit channel of monetary policy in the context of a DSGE model. Through the use of a regulated banking sector subject to a regulatory capital constraint on lending, we provide alternative interpretations that can potentially explain differences in the implementation of monetary policy without appealing to ad-hoc central bank preferences. This is accomplished through the characterization of the external finance premium as a function of bank leverage and systemic aggregate risk.