Exchange Rate Policy and the Bank Lending Channel: Sectoral Evidence from Mexico
Posted: 3 Jul 1997
Date Written: Undated
An important question in macroeconomics has been how the transmission mechanism of monetary policy works. In particular, the question of whether there exists a credit or bank lending channel for the transmission of monetary policy has been one of the central themes in the discussion of the effectiveness of monetary policy. If this channel exists, then shocks to credit markets, particularly to bank loans, can have real effects. This paper presents new evidence on the bank lending; channel hypothesis for the case of Mexico after 1984, when exchange rate policy was the main monetary policy instrument. We present a simple variant of the open economy IS-LM model which includes a credit channel. The model has the following empirical implications which are absent from models which do not include a credit channel. We show that changes in the expectations of devaluation, the desired cash/deposit ratio, and measures of financial deregulation, will have real effects because they change the quantity of credit available in the economy. We explore these implications of the model through standard VAR techniques and find that the evidence strongly supports the credit view for Mexico. We find that the impact on economic activity of nominal depreciation rate shocks, a monetary policy shock, is very significant. Moreover, we find that the production of sectors that a priori are considered to be more dependent on bank credit reacts more to shocks to the depreciation rate than that of sectors that are not. This result is also relevant when trying to explain the booms that are induced by exchange rate stabilizations.
JEL Classification: G24, E60
Suggested Citation: Suggested Citation