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May/June 1995, 
Vol. 77, No. 3
Posted 1995-05-01

Is There a "Credit Channel" for Monetary Policy?

by R. Glenn Hubbard

The author surveys the credit channel for monetary policy. He makes clear that there are two possible credit channels for monetary policy, and that both require asymmetry in the access of “small” and “large” firms to credit. The bank credit channel operates directly on the ability of depository institutions to make loans through the effect of monetary policy actions (open market operations) on bank reserves. For example, restrictive monetary policy actions reduce reserves and, thereby, loans. Unable to obtain bank or other external finance, bank-dependent firms curtail planned spending. The second credit channel, which goes by various names (such as the financial accelerator, excess sensitivity, or the broad lending view), works through the effect of a policy-induced change in interest rates on the balance sheets of borrowers. For example, by reducing their real net worth, a policy-induced increase in the real interest rate makes it difficult for some, typically smaller, firms to attract capital. Unable to attract funds, these firms curtail planned spending. This view differs from the traditional analysis, whereby a policy-induced increase in interest rates makes marginal investment opportunities unprofitable. The author focuses on cross-sectional evidence. He concludes that there is considerable evidence that “the spending decisions of a significant group of borrowers are influenced by their balance sheet condition in the ways described by financial accelerator models.”