Monetary Policy Transmission and Output: The Jordan Experiment

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ABSTRACT

This paper examined the role played by Jordanian banks in reducing the effect of monetary policy actions exerted by the Central Bank on the supply of total credit available for them to lend out.

The results showed that banks characteristic (liquidity and capitalization) can play an important role in reducing the effect of monetary policy actions on the supply of total credit, while the size of banks measured by their total assets does not have a significant effect on the amount of total credit. Also the results suggested that the main operative indicatorsfor monetary policy actions in Jordan are the real three month certificates of deposit rates, the three month certificates of deposit rates, the spread between banks lending rates and deposit rates, and the spread between three month certificates of deposit rates and U.S federal fund rates. A bank lending channel exist in Jordan due to the fact that the main conditions under the bank lending channel theory are maintained which support the existence of the bank lending channel in Jordan, and the total credit has a positive significant effect on the amount of nominal gross domestic product (output).

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INTRODUCTION

In the last years considerable researches had focused on monetary policy transmission mechanism to understand the monetary policy effect on the real economy, many macro economists are always in debates to understand the mechanism through which this policy can works. Knowing about monetary policy transmission are very important, it describes the link between monetary policy actions and their impact on real economic activities and how it affect goal variables other than income, unemployment, inflation, and prices . From this point of view and for the importance of the supply of loans (total credit) offered by commercial bank, we will study the effect of monetary policy transmission through what is known by bank lending channel on the amount of total credit offered by Jordanian banking sectors, and the impact of monetary policy on output.

Standard macro-economic models of aggregate demand had focused mainly on the money significant role, at the same time many economists had worked hardly to interpret and to show the importance of bank loans in the transmission of monetary policy (which is called the bank lending channel). The bank lending channel represents one of the channels that are influenced by the monetary policy actions, and through which monetary policy can works, it focus on the effect of monetary policy on the supply of bank loans especially in the cases where borrowers do not have any alternative sources of bank loans as a source of funding. Monetary policy shocks play an important role in the transmission mechanism through a contraction monetary policy shocks that reduce the assets of banks that are available to lend out, and an expansionary monetary policy shocks that increase those assets. Banks represent the most important source of financing for firms and household, the adjustment and analysis of their lending in response to monetary policy actions constitute an important channel through which monetary policy works, they play a critical role in the transmission of monetary policy actions to the real economy.

Bernanke and Blinder (1992), find that a monetary contraction is followed by a decline in aggregate bank lending. A tightening monetary policy exercised by the Central Banks through the required reserve ratio and the interest rate structure (cost of capital) on the banking sectors as an instrument to ensure the stability in the economy and to control the supply of money in order to protect the economy from the inflation and raising in the prices of goods and services. This action make a reduction in the amount of deposits reserved in the banking system, if banks cannot replace immediately this fall in the loanable funds through liquidating assets or through external source of finance, this will reduce the amount of loans available for banks to make. …