Academic journal article Journal of Money, Credit & Banking

Trade Credit and the Bank Lending Channel

Academic journal article Journal of Money, Credit & Banking

Trade Credit and the Bank Lending Channel

Article excerpt

THE INFLUENCE OF CREDIT MARKET imperfections on the transmission of monetary policy to the real economy is still controversial [see surveys by Bemanke (1993) and Kashyap and Stein (1994)]. Many economists believe that only the "money channel" is important, in particular, that the financial sector is irrelevant. This money channel view holds that when the central bank reduces reserves, higher costs of funds induce banks to reduce their demand deposits. If prices are sticky, this short-run decline in real money balances raises real interest rates to slow interest-sensitive spending and thus economic activity [see Mishkin's (1998) textbook summary of transmission channels].

"Credit channel" proponents believe that credit also plays an important part in the propagation of monetary shocks into the real economy (see, for example, Bernanke and Gertler 1995). The "broad credit channel" view stresses that some firms are subject to an external finance premium, defined as the cost spread between a firms' external funds (bonds, loans, and equity) and its internal funds (retained earnings). According to this theory, higher risk during, for example, a recession sharpens information problems, thus increasing the affected firms' external finance premium and amplifying the policy-induced impact of market rates on firms. Firms lacking access to market credit are those prone to information problems and thus this "financial accelerator."

Proponents of the "bank lending channel," for example, Bernanke and Blinder (1988) and Kashyap and Stein (1994), assert that banks' lending decisions also influence policy transmission, independently of the cost of capital. Accordingly, a reduction in reserves induces banks to scale back lending which disproportionately affects a class of firms that cannot readily switch to other funds, those without access to credit markets. Small firms, for instance, may be more dependent on banks than other firms, and without alternative financing, they may be forced to limit desired investment (or current production) for a given interest rate.

The bank lending channel is perhaps the most contentious transmission mechanism. Romer and Romer (1989) argue that loans do not play an important role since they find that a policy tightening initially impacts interest rates through deposits, not loans. Bernanke and Blinder (1992), though, find that policy shocks affect bank portfolios systematically, which money channel theories cannot explain. (1) Moreover, they find securities is the asset responsible for the immediate post-tightening decline in bank balance sheets and that real activity sags later, at about the same time as the reduction in lending. It is, however, difficult to disentangle whether firms are affected by the slow-down in activity and associated reduction in credit demand or from the loan supply reduction predicted by the bank lending channel. Kashyap, Stein, and Wilcox (1993) ingeniously solve this identification problem by showing that firms issue more commercial paper during monetary contractions. It suggests that firms are using more of a substitute credit because of a loan supply reduction and not that their loan demand is reduced by an activity slowdown. Unfortunately, commercial paper cannot inform about small firms since only large firms issue it (Oliner and Rudebusch 1996). And Gertler and Gilchrist (1994) show that small and large firms exhibit distinctive behavior during tight monetary policy. Small firms suffer loan growth reductions while large firms actually accelerate loans from banks. Thus, the evidence to date still allows interpretation that small firms' bank loan reduction is due to lower demand arising from slower activity.

We make a simple test of the bank lending channel following Kashyap, Stein, and Wilcox but with a substitute credit also available to the (manufacturing) firms suffering the loan decline. Trade credit (TC) is a loan a supplier provides to its customers in conjunction with product sales. …

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