June 2020 issue contents
Credit, Financial Conditions, and Monetary Policy Transmission

David Aikmana, Andreas Lehnertb, Nellie Liangc, and Michele Modungnob


We show that the effects of financial conditions and monetary policy on U.S. economic performance depend nonlinearly on nonfinancial-sector credit. When credit is below its trend, an impulse to financial conditions leads to improved economic performance and monetary policy transmission works as expected. By contrast, when credit is above trend, a similar impulse leads to an economic expansion in the near term, but then a recession in later quarters. In addition, tighter monetary policy does not lead to tighter financial conditions when credit is above trend and is ineffective at slowing the economy, consistent with evidence of an attenuated transmission of policy changes to distant forward Treasury rates in periods of high credit. These results suggest that credit is an important conditioning variable for the effects of financial variables on macroeconomic performance.

JEL Code: E58, E65, G28.

Full article (PDF, 39 pages, 5,362 kb)

a Bank of England
b Federal Reserve Board
c Brookings Institution