Inside the black box: How important is the credit channel relative to the interest and exchange rate channels?

Abstract

This paper develops a dynamic general equilibrium model to assess the importance of the credit channel relative to the interest and exchange rate channels. It is motivated by increasing theoretical and empirical evidence that credit market conditions affect the propagation of cyclical fluctuations in the economy. The relative contribution of each channel is determined by comparing the impulse responses when the relevant channel is suppressed with the impulse responses when all three channels are operating. The analysis shows that all three channels affect business cycle dynamics. But the interest rate channel has the largest effects in the transmission of shocks to the economy. The results suggest that it is substantially more important than the credit channel. Show more