A simple model of money, credit and aggregate demand
AbstractThe paper presents a theoretical model of how banks and the non-bank private sector respond to changes in monetary policy. Unlike many textbook models in which banks play no active role, the banking sector is recognised here as playing a key part in transmitting changes in monetary policy to the real economy. In a conventional IS/LM model, the impact of a change in monetary policy arises from the response of expenditure to changes in interest rates (the "monetary" channel). If, however, bank and non-bank sources of credit are not perfect substitutes (for example because some borrowers have only limited access to capital markets) then changes in monetary policy could also have an effect through their impact on the availability or the relative price of bank credit (a "credit" channel). The paper sets out the conditions under which this credit channel reinforces or weakens the impact of changes in monetary policy on the behaviour of the non-bank private sector. One example of the case where the credit channel could weaken the impact of changes in monetary policy would be where banks do not pass on changes in official interest rates fully or immediately to some of their customers. In this context the paper acknowledges the results of the two Bank studies of bank lending to small businesses.
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Bibliographic InfoPaper provided by Bank of England in its series Bank of England working papers with number 7.
Date of creation: Apr 1993
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