The Lending Channel under Optimal Choice of Monetary Policy
Bank of Finland - Research
Loughborough School of Business and Economics
Bank of Finland Research Discussion Paper No. 33/2007
Building on Cecchetti and Li (2005), we show that the bank lending channel affects monetary policy trade-offs only when interest rates affect marginal costs of production (ie when there is a cost channel of monetary policy) in the New Keynesian monetary policy model. In our calibrated model the resulting impact of the bank lending channel on output-inflation trade-offs is quantitatively small and of ambiguous sign. When bank capital varies counter cyclically and bank loan rates have a relatively large impact on marginal costs, variation of bank loan margins improves monetary policy trade-offs. The new Basel accord, by increasing capital requirements during economic downturns, offsets this beneficial impact.
Number of Pages in PDF File: 42
Keywords: bank capital, bank lending, capital buffers, pro-cyclicality, capital regulation, cost channel, credit channel, loan margins, monetary trade-offs
JEL Classification: E51, E52, G21working papers series
Date posted: January 31, 2008
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