The Credit Channel in an Emerging Economy

To date, there is no consensus about how frictions in the credit market affect the transmission of the monetary policy to the real economy. The traditional money channel states that when the Central Bank reduces its reserves, commercial banks are forced to reduce their demand for deposits. If prices are sticky, in the short-run a decrease in real monetary holdings should lead to higher real interest rates and should translate into a contraction of interest-sensitive components of aggregate spending. The most recent literature has focused on the role of the credit channel. This states that the direct effect of monetary policy on interest rates is amplified by changing the terms and availability of bank loans. Given that firms and consumers lack perfect substitutes for bank loans, they will be unable to offset the reduced supply of loans. This article focuses on testing the existence of a credit channel in Chile. Our sample comprises 19 banks that operated in Chile over January 1999-December 2002. Over that period, banks primarily offered loans to firms in the manufacturing and the financial services sectors (13 and 26 percent of total loans, respectively), and to individuals through consumption and mortgage loans (9 and 10 percent of total loans, respectively). Our estimation results show that the loans supply and the deposits demand are affected by bank characteristics—such as liquidity, size, past-due loans share, and capitalization—economic activity, the level of interest rates, real exchange depreciation, and by the Santiago Stock Exchange trading. Our results support the existence of a credit channel in the Chilean economy.