Effects of monetary policy and credibility on financial intermediation: evidence from the Brazilian banking sector

Since, under inflation targeting (IT), the main monetary policy instrument to control inflation is the basic interest rate, an important question that arises is: How do changes in this instrument affect financial intermediation? On the other hand, under IT, one of the main goals of the central bank is to make monetary policy credible. In this sense, how can credibility affect the relation between monetary policy and financial intermediation? Are the transmission mechanism and the effects of credibility the same for state-owned banks and privately owned banks? Using data from the Brazilian banking sector, this paper analyzes the effects of monetary policy on financial intermediation and investigates the existence of the "Paradox of Credibility." The findings suggest the monetary policy interest rate affects financial intermediation. Moreover, the results show that credibility is able to cushion the effect of monetary policy on financial intermediation. And finally, the results reveal how the different effects analyzed in the paper, and especially the mitigating effect of credibility, differ between privately owned and state-owned banks.