Bank Coordination and Monetary Transmission: Evidence from India

54 Pages Posted: 6 Oct 2020

See all articles by Shiv Dixit

Shiv Dixit

Indian School of Business

Krishnamurthy Subramanian

Indian School of Business (ISB), Hyderabad

Date Written: August 10, 2020

Abstract

We propose a new channel for the transmission of monetary policy shocks, the coordination channel. We develop a New Keynesian model in which bank lending is strategically complementary. Banks do not observe the distribution of loans but infer it using Gaussian signals. Under this paradigm, expectations of tighter credit conditions reduce banks’ lending response to monetary shocks. As a result, lack of coordination and information about other banks’ actions dampen monetary transmission. We test these predictions by constructing a dataset that links the evolution of interest rates to firms’ bank credit relationships in India. Consistent with our model, we find that the cross-sectional mean and dispersion of lending rates, which capture the expected value and the precision of the signals of credit extended by other banks, are significant predictors of monetary transmission. Our quantitative results suggest that lending complementarities reduce monetary transmission to inflation and output by about a third.

Keywords: E43, E52, G21

JEL Classification: Monetary policy transmission, India, lending rates

Suggested Citation

Dixit, Shiv and Subramanian, Krishnamurthy, Bank Coordination and Monetary Transmission: Evidence from India (August 10, 2020). Available at SSRN: https://ssrn.com/abstract=3676389 or http://dx.doi.org/10.2139/ssrn.3676389

Shiv Dixit (Contact Author)

Indian School of Business ( email )

Sector 81
Mohali, 143006
India

HOME PAGE: http://shivdixit.com

Krishnamurthy Subramanian

Indian School of Business (ISB), Hyderabad ( email )

Hyderabad, Gachibowli 500 019
India

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