Abstract
AbstractWe characterize the response of U.S. real GDP to monetary policy shocks conditional on the level of private sector debt and the degree to which financial constraints are binding. To incorporate state‐dependent effects of monetary policy, we use the local projection framework. We find that although the amount of private sector debt potentially weakens the monetary policy transmission mechanism, policy shocks exert substantially larger effects on output when high private debt coincides with binding financial constraints.
Highlights
IntroductionThe level of private debt may influence the monetary transmission mechanism through several channels
Is the economy more sensitive to changes in monetary policy if the private sector is indebted? Theoretically, the level of private debt may influence the monetary transmission mechanism through several channels
We show how private debt and financial constraints influence the effects of monetary policy
Summary
The level of private debt may influence the monetary transmission mechanism through several channels. Firms’ balance sheets and the net worth of households in the presence of binding credit constraints and collateral requirements represent another channel through which monetary policy is transmitted to the real economy (Bernanke and Gertler, 1995). For instance, raises the value of the collateral, it increases the availability of credit, which in turn influences spending and investment decisions. Guerrieri and Iacoviello (2017) develop and estimate a DSGE model with occasionally binding constraints. In their model, shocks to house prices exert larger effects on consumption when the level of household debt is higher and borrowing constraints are binding.. Shocks to house prices exert larger effects on consumption when the level of household debt is higher and borrowing constraints are binding. a higher overall level of private debt implies that these effects should
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