Credit Market Shocks, Monetary Policy, and Economic Fluctuations

This paper uses a dynamic stochastic general equilibrium model with credit market imperfections to estimate the role of credit market shocks and monetary policy in us business cycles. The estimated model captures much of the historical narrative regarding the conduct of monetary policy and developments in financial markets that led to episodes of financial excess and distress over the last two decades. The estimation suggests that credit market shocks are an important factor behind economic fluctuations accounting for 15% of the variance in real output since 1985. In addition, we find that once credit market imperfections are considered, monetary policy is also an important force behind real output fluctuations explaining 12.5% of its variance.