Research Discussion Papers, Bank of Finland
No 2/2009:
The bank lending channel reconsidered
Alistair Milne ()
and Geoffrey Wood
Abstract: It has been widely accepted that constraints on the
wholesale funding of bank balance sheets amplify the transmission of
monetary policy through what is called the ‘bank lending channel’. We show
that the effect of such bank balance sheet constraints on monetary
transmission is in fact theoretically ambiguous, with the prior
expectation, based on standard theoretical models of household and
corporate portfolios, that the bank lending channel attenuates monetary
policy transmission. We examine macroeconomic data for the G8 countries and
find no evidence that banking sector deposits respond negatively and more
than lending to tightening of monetary policy, as the accepted view of the
bank lending channel requires. The overall picture is mixed, but these data
generally suggest that deposits fluctuate procyclically and somewhat less
over the business cycle than bank lending, and that total bank deposits,
unlike bank lending, show little direct response to changes in interest
rates. This suggests it is very unlikely that the bank lending channel
amplifies monetary policy. Our paper has thus corrected a misunderstanding
about the role of banks in monetary policy transmission that has persisted
in the literature for some two decades.
Keywords: credit channel; monetary transmission; bank financing constraints; (follow links to similar papers)
JEL-Codes: E44; E52; G32; (follow links to similar papers)
59 pages, January 21, 2009
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