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Bank lending, financial frictions, and inside money creation

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  • Lukas Altermatt

Abstract

I build a general equilibrium model of the transmission of monetary policy on bank lending. Bank lending is done by individual banks that face random investment opportunities by creating inside money. Banks are subject to a reserve requirement and have access to the interbank money market. The model shows that lowering the money market rate relative to the inflation rate reduces investment and welfare. This is because the money market is an outside option for banks that face bad investment opportunities. Reducing the money market rate lowers the value of this outside option, which in turn reduces banks’ willingness to acquire reserves ex-ante. This leads to less aggregate reserves, which reduces the banking system’s ability to grant credit.

Suggested Citation

  • Lukas Altermatt, 2019. "Bank lending, financial frictions, and inside money creation," ECON - Working Papers 325, Department of Economics - University of Zurich.
    • Handle: RePEc:zur:econwp:325
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    File URL: https://www.econ.uzh.ch/apps/workingpapers/wp/econwp325.pdf
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    References listed on IDEAS

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    1. Ricardo Lagos & Randall Wright, 2005. "A Unified Framework for Monetary Theory and Policy Analysis," Journal of Political Economy, University of Chicago Press, vol. 113(3), pages 463-484, June.
    2. Lukas Altermatt, 2022. "Inside Money, Investment, And Unconventional Monetary Policy," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 63(4), pages 1527-1560, November.
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    6. Thaler, Dominik, 2018. "A Large Central Bank Balance Sheet? The Role of Interbank Market Frictions," VfS Annual Conference 2018 (Freiburg, Breisgau): Digital Economy 181632, Verein für Socialpolitik / German Economic Association.
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    Cited by:

    1. Heon Lee, 2021. "Money Creation and Banking: Theory and Evidence," Papers 2109.15096, arXiv.org.

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    More about this item

    Keywords

    Monetary policy transmission; open market operations; channel system; interest rate pass-through;
    All these keywords.

    JEL classification:

    • E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit

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