The Bank Lending Channel of Monetary Policy and its Macroeconomic Effects: Evidence from a Sample of Selected Euro Area Countries

Abstract

Monetary policy measures can affect the supply and demand for bank loans through several transmission mechanisms: the credit channel (that encompasses the bank lending channel and the balance sheet channel), the bank capital channel, and the risk-taking channel. This paper aims to provide evidence on whether the bank landing channel in the selected euro area countries as a whole is operational. Unlike the existent studies we test for differences of the bank lending channel relevance for the large and the small and medium-sized enterprises (SMEs). We apply a macro identification strategy to identify loan supply shocks attributable to the banks’ balance sheet constraints and use them in a typical monetary policy VAR model to verify the existence of the bank lending channel. Additionally, we provide evidence on how the shocks in loan activity affect output and inflation. The analysis of impulse responses reveals that a negative shock (an increase in the policy rate) leads to a significant increase in credit standards for large enterprises as well as the SMEs. This implies that the restrictive monetary policy shock increases banks’ balance sheet constraints and that the banks in the short run respond by tightening credit standards for enterprises. Tightening credit standards shock in turn negatively impacts the growth of business loans. The empirical results thus provide evidence that the bank lending channel is operational. A negative shock to the credit standards reduces output in the short run, yet no significant impact on inflation can be observed. When banks unexpectedly tighten credit standards for SMEs the monetary policy (European central bank) seems to respond in a more pronounced manner (by reducing monetary policy rate more) than when banks tighten credit standards for large enterprises.

DOI: http://dx.doi.org/10.5755/j01.ee.27.2.12647