The Role of Financial Depth on the Asymmetric Impact of Monetary Policy

This paper investigates the role of financial markets in evaluating the asymmetric impact of monetary policy on real output over the business cycle. We use quarterly US data which cover 1971:q1-2011:q4 and implement an instrumental variables Markov regime switching methodology to account for the endogeneity problem. Our investigation shows that monetary policy has a significant impact on output growth during recessions. More interestingly, we find that financial depth plays an important role as it dampens the effects of monetary policy in recessions. The results are robust compared to an alternative financial depth measure and a different sample period.