The Lending Channel under Optimal Choice of Monetary Policy

42 Pages Posted: 31 Jan 2008

See all articles by Juha Kilponen

Juha Kilponen

Bank of Finland - Research

Alistair Milne

Loughborough University - School of Business and Economics

Abstract

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.

Keywords: bank capital, bank lending, capital buffers, pro-cyclicality, capital regulation, cost channel, credit channel, loan margins, monetary trade-offs

JEL Classification: E51, E52, G21

Suggested Citation

Kilponen, Juha and Milne, Alistair K. L., The Lending Channel under Optimal Choice of Monetary Policy. Bank of Finland Research Discussion Paper No. 33/2007. Available at SSRN: https://ssrn.com/abstract=1088274 or http://dx.doi.org/10.2139/ssrn.1088274

Juha Kilponen

Bank of Finland - Research ( email )

P.O. Box 160
FIN-00101 Helsinki
Finland
+358 10 831 2847 (Phone)
+358 10 831 2294 (Fax)

HOME PAGE: http://www.bof.fi/en/suomen_pankki/organisaatio/asiantuntijoita/kilponen_juha/

Alistair K. L. Milne (Contact Author)

Loughborough University - School of Business and Economics ( email )

Epinal Way
Loughborough
Leicestershire, LE11 3TU
United Kingdom

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