Monetary Policy, Credit and Aggregate Supply : The Evidence from Italy

This paper concerns theory and evidence of the monetary transmission mechanisms. Current research has deeply investigated factors, such as dependence of firms on bank credit, that amplify the impact of monetary policy impulses on aggregate demand exerting strong but temporary effects on output and employment. We present an intertemporal macroeconomic equilibrium model of a competitive economy where current production is financed by bank credit, and then we use it to identify supply-side effects of the credit transmission mechanism in data drawn from the Italian economy. We find evidence that the 'credit variables' identified by the model - the overnight rate as a proxy of monetary policy and a measure of credit risk - have permanent effects on employment and output by altering credit supply conditions to firms. To save on space, mathematical proofs, statistical tests and data sources have been gathered in two separate appendices that can be examined on request