The balance sheet channel
We study the role of the balance sheet channel of monetary policy in an environment in which credit plays an important role in the funding of new capital investment. Specifically, we ask whether the transmission mechanism of monetary policy is altered in an environment in which financial intermediation with agency costs, aggregate risk on the performance of loans, and banking regulations are all features that can potentially amplify the impact of shocks over the cycle. Because monetary policy has empirically been asymmetric and marked by periods of pronounced action, our approach provides an alternative plausible mechanism that generates the necessary intuition to account for these patterns. Our model is consistent with current New Neoclassical Synthesis models in good times. In bad times (or crisis periods), when systemic losses are potentially large, the model can generate sharp changes in the external finance premium and, therefore, in the patterns of investment.