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Monetary Policy and the Credit Rationing Effects of Liquidity

Author

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  • Jonathan Swarbrick

    (University of St Andrews)

Abstract

This paper studies monetary policy in a New Keynesian economy with frictional bank lending, rationalising evidence that lending conditions can remain tight despite liquidity injections. The model features a policy trade-off in which increases in banking sector liquidity can incentivise more lending by lowering the overnight rate and the marginal cost of funds, but can also incentivise less lending by compressing bank margins as interest rates approach the policy floor, worsening adverse selection and credit rationing. As a result, quantitative easing can exert a contractionary effect when the economy is away from the effective lower bound, with outcomes depending on borrower risk and the size of the programme. However, both channels raise inflation expectations, and so liquidity policies are always expansionary at the lower bound. Optimal policy features a deflation bias under credit rationing, while commitment to future accommodation eases current credit conditions and implies gradualism in quantitative tightening.

Suggested Citation

  • Jonathan Swarbrick, 2026. "Monetary Policy and the Credit Rationing Effects of Liquidity," Economics Discussion Papers 2601, Department of Economics, The University of St Andrews Business School.
    • Handle: RePEc:san:econdp:2601
    as

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    File URL: https://www.st-andrews.ac.uk/~wwwecon/repecfiles/econdp/2601.pdf
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    References listed on IDEAS

    as
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    Keywords

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    JEL classification:

    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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