Does the composition of credit matter for Australian monetary policy transmission?

Abstract

The composition of credit is rarely discussed when quantifying the role of credit in Australian monetary policy transmission. As the share of household and business credit has changed, it is important to understand whether the composition will matter for monetary policy transmission. I use a SVAR model to quantify the sensitivity of household and business credit to monetary policy finding relatively symmetric responses for all components. However, the SVAR model fails to account for the changing share of household and business credit. Implementing a DSGE model with credit, I construct three compositions representative of Australia’s credit composition since 1992. Household credit is shown to be more sensitive to a tightening of monetary policy as the share of household credit increases, as has occurred in Australia. Meanwhile, a business-dominant composition will propagate monetary policy shocks to investment and output. Furthermore, a shock to borrowing constraints implies the gradual change in credit composition will impact Australia’s financial stability more broadly as business credit has the strongest relationship with macroeconomic variables. As the share of business credit has gradually declined, the effectiveness of monetary policy transmission through credit to key macroeconomic variables may have decreased.