Monetary policy transmission under high bank spread

Orientador(a): Yvan Becard

We analyze the influence of high credit spread on the transmission of monetary policy. We develop a macroeconomic model that generates endogenous credit spread with two main ingredients: banks that operate in Cournot competition and defaulting firms whose assets exhibit low recovery rate. The model implies that imperfect banking competition mitigates the effects of a monetary shock while credit frictions amplify them, indicating the presence of two transmission channels acting in opposite directions. A calibration consistent with Brazil shows that the second channel dominates the first, revealing that high credit spreads amplify the impact of a monetary shock on inflation but at a considerable cost in terms of lost output. To deal with such inefficiency, we propose an alternative monetary rule that takes into account changes in the spread. Our results suggest that this alternative rule reduces welfare losses, offering a promising avenue for central banks to balance inflation control and output concerns.