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Monetary policy and credit conditions: evidence from the composition of external finance

  • Anil K. Kashyap
  • Jeremy C. Stein
  • David W. Wilcox

In this paper we use the relative movements in bank loans and commercial paper to provide evidence on the existence of a loan supply channel of monetary policy transmission. A first necessary condition for monetary policy to work through a lending channel is that banks must view loans and securities as imperfect substitutes, so that monetary tightening does affect the availability of bank loans. We find that tighter monetary policy leads to a shift in firms' mix of external financing -- commercial paper issuance rises while bank loans fall, suggesting that loan supply has indeed been reduced. Furthermore, these shifts in the financing mix seem to affect investment (even controlling for interest rates). This implies that bank and non-bank sources of finance are also not perfect substitutes for businesses. We also argue that this view of the transmission mechanism can help explain why interest rate spreads involving commercial paper rates have had considerable predictive power for many measures of economic activity.

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Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 154.

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Date of creation: 1991
Date of revision:
Handle: RePEc:fip:fedgfe:154
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  1. Fama, Eugene F., 1985. "What's different about banks?," Journal of Monetary Economics, Elsevier, vol. 15(1), pages 29-39, January.
  2. James H. Stock & Mark W. Watson, 1989. "New Indexes of Coincident and Leading Economic Indicators," NBER Chapters, in: NBER Macroeconomics Annual 1989, Volume 4, pages 351-409 National Bureau of Economic Research, Inc.
  3. Benjamin M. Friedman & Kenneth N. Kuttner, 1991. "Why does the paper-bill spread predict real economic activity?," Working Paper Series, Macroeconomic Issues 91-16, Federal Reserve Bank of Chicago.
  4. Alan S. Blinder & Louis J. Maccini, 1991. "Taking Stock: A Critical Assessment of Recent Research on Inventories," Journal of Economic Perspectives, American Economic Association, vol. 5(1), pages 73-96, Winter.
  5. Hoshi, Takeo & Kashyap, Anil & Scharfstein, David, 1990. "The role of banks in reducing the costs of financial distress in Japan," Journal of Financial Economics, Elsevier, vol. 27(1), pages 67-88, September.
  6. Stiglitz, Joseph E & Weiss, Andrew, 1981. "Credit Rationing in Markets with Imperfect Information," American Economic Review, American Economic Association, vol. 71(3), pages 393-410, June.
  7. Diamond, Douglas W, 1984. "Financial Intermediation and Delegated Monitoring," Review of Economic Studies, Wiley Blackwell, vol. 51(3), pages 393-414, July.
  8. Benjamin M. Friedman, 1982. "Debt and Economic Activity in the United States," NBER Chapters, in: The Changing Roles of Debt and Equity in Financing U.S. Capital Formation, pages 91-110 National Bureau of Economic Research, Inc.
  9. Takeo Hoshi & Anil Kashyap & David Scharfstein, 1989. "Corporate structure, liquidity, and investment: evidence from Japanese industrial groups," Finance and Economics Discussion Series 82, Board of Governors of the Federal Reserve System (U.S.).
  10. Gilson, Stuart C. & John, Kose & Lang, Larry H. P., 1990. "Troubled debt restructurings*1: An empirical study of private reorganization of firms in default," Journal of Financial Economics, Elsevier, vol. 27(2), pages 315-353, October.
  11. King, Stephen R, 1986. "Monetary Transmission: Through Bank Loans or Bank Liabilities?," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 18(3), pages 290-303, August.
  12. L. Wade, 1988. "Review," Public Choice, Springer, vol. 58(1), pages 99-100, July.
  13. Maccini, Louis J & Rossana, Robert J, 1981. "Investment in Finished Goods Inventories: An Analysis of Adjustment Speeds," American Economic Review, American Economic Association, vol. 71(2), pages 17-22, May.
  14. Benjamin M. Friedman, 1981. "Debt and Economic Activity in the United States," NBER Working Papers 0704, National Bureau of Economic Research, Inc.
  15. James Tobin, 1987. "Financial Intermediaries," Cowles Foundation Discussion Papers 817, Cowles Foundation for Research in Economics, Yale University.
  16. Christina D. Romer & David H. Romer, 1990. "New Evidence on the Monetary Transmission Mechanism," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 21(1), pages 149-214.
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