How important is the credit channel? An empirical study of the US banking crisis

We examine whether by adding a credit channel to the standard New Keynesian model we can account better for the behaviour of US macroeconomic data up to and including the banking crisis. We use the method of indirect inference which evaluates statistically how far a model’s simulated behaviour mimics the behaviour of the data. We find that the model with credit dominates the standard model by a substantial margin. Credit shocks are the main contributor to the variation in the output gap during the crisis.