1. Aksoy: School of Economics, Mathematics and Statistics, Birkbeck, University of London, Malet Street, WC1E 7HX, London, UK. Phone +44 20 7631 6407, Fax +44 20 7631 6416, E-mail yaksoy@ems.bbk.ac.uk
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    1. Basso: Department of Economics, University of Warwick, Coventry CV4 7AL, UK. E-mail h.basso@warwick.ac.uk
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    1. Coto-Martinez: Department of Economics and Finance, Brunel University, Uxbridge, Middlesex, UB8 3PH, UK. E-mail Javier.Coto-Martinez@brunel.ac.uk
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    • We would like to thank an anonymous referee, Paul De Grauwe, Nils Gottfries, Gülçin Özkan, Ron P. Smith, Andy Snell, Peter Tinsley, our discussant Andreas Beyer and participants at seminars at the Bank of England, Riksbank, Banco de Espana, Brunel University, Cagliari University, University of Leuven, Uppsala University, and participants at the Bank of Finland/CEPR Conference in Helsinki in 2009, XXXIV SAE meeting in Valencia, EEA meetings in Glasgow in 2010, the Rimini Conference in Economics and Finance in 2010, and the “Macroeconomic modelling and policy analysis after the global financial crisis conference” in Frankfurt in 2010 for comments and suggestions. The usual disclaimer applies.


Financial intermediation and bank spreads are the important elements in the analysis of business cycle transmission and monetary policy. We present a simple framework that introduces lending relationships, a relevant feature of financial intermediation that has been so far neglected in the monetary economics literature, into a dynamic stochastic general equilibrium model with staggered prices and cost channels. Our main findings are (a) banking spreads move countercyclically generating amplified output responses, (b) spread movements are important for monetary policymaking even when a standard Taylor Rule is employed, (c) modifying the policy rule to include a banking spread adjustment improves stabilization of shocks and increases welfare when compared to rules that only respond to output gap and inflation, and finally (d) the presence of strong lending relationships in the banking sector can lead to indeterminacy of equilibrium forcing the Central Bank to react to spread movements. (JEL E44, E52, G21)