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The impact of monetary policy on bank balance sheets: An analysis of the money and credit channel views in the transmission mechanism of monetary policy
Abstract
Conventional wisdom holds that monetary policy is neutral over the long run, but in the short run it is capable of exerting a significant influence on the course of real activity. Despite this general acknowledgment, much less of a consensus exists on how exactly its effect is transmitted into the economy. While there is a widespread belief that banks assume a key role in the transmission process, there is considerable controversy over the precise role that banks play. Two views, the money channel and the credit channel, have been proposed as explanations to these unresolved issues. The role of banks in the transmission process is examined in this dissertation. This is accomplished by analyzing the response of bank balance sheets, particularly their portfolio allocations, toward changes in monetary policy. Both channels of monetary transmissions are incorporated into the model developed for this study. Banks are passive toward monetary shock when only the money channel is considered. Incorporation of the credit channel assigns a more significant and active role for banks. Thus, the net impact of monetary policy on bank balance sheets is determined by the relative strength of each channel of the transmission mechanism. The strength of each channel is also affected by deregulation and innovation in the banking industry. These forces determine the ability of monetary authority to influence bank decisions and in turn measure the effectiveness of monetary policy. The results of the empirical analysis support the importance of the credit channel. Banks' reactions to monetary shocks are largely explained by the credit market effect. Prior to 1980 the money channel was significant, but its significance has diminished notably since. Banking decisions play an important role in determining the effectiveness of monetary policy. The ability of monetary authority to directly influence bank behavior has been lessened by recent institutional changes. A better understanding of monetary transmission can be achieved by incorporating bank behavior into the monetary equilibrium model.
Subject Area
Economics|Finance|Banking
Recommended Citation
Ghazali, Noor Azlan, "The impact of monetary policy on bank balance sheets: An analysis of the money and credit channel views in the transmission mechanism of monetary policy" (1997). ETD collection for University of Nebraska-Lincoln. AAI9725123.
https://digitalcommons.unl.edu/dissertations/AAI9725123