Tuning the Hydraulics:Financial and labor market channels of monetary policy transmission

Abstract

This paper estimates models identified by heteroskedasticity and models identified with sign restrictions to study the interaction between credit spreads, credit aggregates, and the real effects of monetary policy. In both identification schemes, the inclusion of both business and household credit aggregates helps to sharpen the identification. We find that while both credit and monetary shocks lead to output contraction and disinflation, the two are distinguished by their respective effects on business and household credit. Proper identification of monetary shocks, especially in the identification frameworks explored in this paper, is therefore contingent on the inclusion of these variables. In contrast, we document that while the labor market variables respond strongly to monetary shocks, those responses are mostly passive.