Academic journal article Journal of Money, Credit & Banking

Credit Market Imperfections and the Heterogeneous Response of Firms to Monetary Shocks

Academic journal article Journal of Money, Credit & Banking

Credit Market Imperfections and the Heterogeneous Response of Firms to Monetary Shocks

Article excerpt

Borrowing and sales by small firms falls significantly relative to large firms following a monetary contraction. Moreover, the spread between the interest rate on loans paid by "bank-dependent" firms compared to firms that use public debt markets for external finance rises during a monetary contraction.(1) This evidence has been interpreted as an implication of quantitatively important frictions in credit markets. Generally, there are two views about how imperfect credit markets influence the transmission of monetary shocks. One emphasizes the role of net worth in the determination of the premium paid by borrowers for external finance. The other focusses on the ability of monetary policy to influence the supply of loanable funds at banks.(2) This latter view is often referred to as the bank-lending channel of the monetary transmission mechanism or, simply, the lending view. The objective of this paper is to assess the interpretation of the empirical evidence that says it reflects the lending view.

The foundation of the analysis is a general equilibrium model which embodies the friction conventionally employed to characterize the macroeconomic implications of imperfect credit markets. The model is designed to capture important features of the monetary transmission mechanism that have been attributed to the lending view and it has predictions for the responses of small and large firms and the spread between interest rates faced by bank-dependent versus non-bank-dependent firms to money supply disturbances. I use this model to evaluate the lending view in two ways. The first relies on the entire structure of the model. I calibrate parameters using long-run features of the data and examine whether the model based on these parameters can replicate the key observations. I find that the model fails along this dimension--only with seemingly implausible parameters does it replicate the observations of interest. This is despite the fact that the steady state of the calibrated model does a good job at accounting for long-run features of the data associated with the lending view.

These results could be sensitive to the details of the general equilibrium specification and in particular the assumptions underlying the monetary transmission mechanism. The second way I assess the lending view is an attempt to address this concern. The strategy here is to assume particular variables in the general equilibrium model are exogenous and to study the resulting partial equilibrium model of the credit market. Parameter values are taken from those implied by the general equilibrium calibration procedure. However, instead of using the general equilibrium model's implications for how the exogenous variables respond to monetary shocks, I estimate their responses directly from U.S. Data. These estimates are then taken as given in the partial equilibrium model and the remaining parameter values are chosen to replicate the empirical observations. I find again that only for seemingly implausible parameters can the key observations be replicated. Thus, the finding reached on the basis of the general equilibrium model does not depend on the assumptions underlying its treatment of the monetary transmission mechanism.

The extent to which these results cast doubt on the lending view interpretation of the empirical evidence depends on the model's success at capturing the main tenets of this view. As it is usually described, the lending view can be decomposed into two distinct elements.(3) First, the monetary authority must be able to influence the real supply of loanable funds. This idea is captured in the model using the limited participation assumption associated with Lucas (1990) and Fuerst (1992).(4) Second, frictions must exist that force some firms to depend on banks, rather than public debt markets, for external finance. As is conventional, I model this using the costly state verification framework introduced by Townsend (1979) and Gale and Hellwig (1985). …

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