Firm Balance Sheets and Monetary Policy Transmission

41 Pages Posted: 28 Jan 2006

See all articles by Adam B. Ashcraft

Adam B. Ashcraft

Federal Reserve Bank of New York

Murillo Campello

Cornell University - Samuel Curtis Johnson Graduate School of Management; National Bureau of Economic Research (NBER)

Abstract

Exploring the functioning of internal capital markets in financial conglomerates, this paper conducts a novel test of the credit channel of monetary policy. We look at differences in the response of lending to monetary policy shocks across small banks that are affiliated with the same bank holding company but that operate in different geographical areas. These banks tap into the same pool of funds but face different pools of borrowers. Because small subsidiary banks concentrate their lending with small local businesses (whose fortunes are tied to their local economies), we can exploit cross-sectional differences in local economic conditions at the time of a monetary policy shock to study whether the strength of borrowers' balance sheets influences the response of bank lending to policy. We find evidence that the negative response of bank loan growth to a monetary contraction is significantly more (less) pronounced when borrowers are more likely to have weak (strong) balance sheets. On the flip side, borrowers with weak balance sheets obtain more new bank credit than other borrowers in monetary expansions. Our results are consistent with the operation of a demand-driven transmission mechanism that works independently of the bank-supply (lending) channel. In fact, our estimates suggest that borrowers' balance sheet strength accounts for a significant fraction of the broad credit channel of monetary policy.

Keywords: Firm Financial Constraints, Monetary Policy, Balance Sheet Channel, Financial Conglomerates, Internal Capital Markets

JEL Classification: E50, E51, G22

Suggested Citation

Ashcraft, Adam B. and Campello, Murillo, Firm Balance Sheets and Monetary Policy Transmission. Journal of Monetary Economics, Forthcoming. Available at SSRN: https://ssrn.com/abstract=878406

Adam B. Ashcraft

Federal Reserve Bank of New York ( email )

33 Liberty Street
New York, NY 10045-0001
United States
212-720-1617 (Phone)
212-720-8363 (Fax)

Murillo Campello (Contact Author)

Cornell University - Samuel Curtis Johnson Graduate School of Management ( email )

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Ithaca, NY 14853
United States

HOME PAGE: http://www.johnson.cornell.edu/Faculty-And-Research/Profile.aspx?id=mnc35

National Bureau of Economic Research (NBER) ( email )

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Cambridge, MA 02138

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