Model of the Monetary Transmission Mechanism Through the Banking Channel and Sovereign Risk for an Underdeveloped Economy Like Mexico
Abstract
Monetary transmission channels are financial mechanisms that incorporate signals from monetary policy and transfer them to the real economy. From a theoretical perspective, the proper functioning of these mechanisms indirectly contributes to guiding economic dynamics toward a steady state. The bank credit channel is one of the five main transmission channels. Research on the functioning of the bank credit channel has been primarily based on characteristics of developed economies. For underdeveloped economies, it is still not possible to fully explain how the effects of monetary policy are transmitted to economic activity. The overall objective of this research is to further characterize the bank credit channel by incorporating sovereign risk, market power, and international liquidity into the analytical framework-characteristics typical of an underdeveloped economy. This is achieved through a dynamic panel model, resulting in a financial system with a strong presence of short-term foreign capital and a high propensity for risk.
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