Academic journal article Federal Reserve Bank of New York Economic Policy Review

Commentary

Academic journal article Federal Reserve Bank of New York Economic Policy Review

Commentary

Article excerpt

Cara Lown and Donald Morgan's paper does two very important things. First, it draws attention to a data set that may shed new light on the effects of monetary policy, the financing choices of firms, and the industrial organization of the banking sector: the Federal Reserve's Senior Loan Officer Opinion Survey. Second, it reminds us that the bank lending market is more complex than common stories of the lending channel suggest-and that studying those complexities may help solve important macroeconomic questions. These comments fall under five headings: explaining why credit standards are important, discussing whether the variables chosen actually reflect differences in standards, describing how well the argument addresses endogeneity problems, interpreting the results, and suggesting future research.

WHY ARE STANDARDS IMPORTANT?

As Lown and Morgan remind us, obtaining a bank loan has two stages. First, banks decide whether to make loans at all, based on a set of standards the potential borrower must meet. Second, the bank and borrower must negotiate loan terms and quantity.

Traditional stories of the credit channel of monetary policy (for example, Bernanke and Blinder [1988]) have largely neglected the first stage. For most empirical studies, and even most of the (rather few) theoretical models, this is not problematic. Studies have seldom used loan interest rates; they instead attempt to determine whether exogenous shifts in monetary policy or bank-related variables cause changes in the quantity of bank loans or changes in macro-level variables and micro-level firm behavior. This focus on loan quantities leads to results equally consistent with a credit-rationing or a price-- increase story. In fact, a typical description of what happens during a credit crunch is that small firms are "unable to borrow" after a monetary policy contraction.

So why consider standards? Increases in standards are likely to reduce the quantity of bank lending-if firms are unwilling or unable to meet new standards. Hence, to the extent that changes in standards are exogenous, standards will be good instrumental variables for shifts in the loan supply.

There are at least four reasons why standards might change:

* Banks decide to change standards for reasons unrelated to the current or future state of the macroeconomy.

* Open market operations lead to changes.

* Banks tighten or ease lending as a result of moral suasion by the Fed.

* Banks change standards in response to perceived changes in loan demand.

The first reason might involve regulatory changes or changes in the industrial organization of the banking industry that are unrelated to the economy as a whole. The next two reasons provide additional channels through which monetary policy can have real effects. Moral suasion is of particular interest as the return of an old idea that is now largely abandoned. I was once taught that there were four ways of carrying out monetary policy: performing open market operations, changing the discount rate, changing reserve requirements (or perhaps other banking regulations), or exerting "moral suasion." Moral suasion includes attempts by the Fed to persuade banks to change their lending policies. Consider Friedman and Schwartz's (1963) discussion of monetary policy in 1919:

In April 1919, the Board gave serious consideration to the suggestion " . . . that the discount rate be advanced." Yet it restricted itself to moral suasion, urging banks to discriminate between "essential and non-essential credits"-a formula that successive use from that time has rendered neither less appealing to the Reserve System as a means of shifting responsibility nor more effective as a means of controlling monetary expansion (p. 222).

In discussing postwar policy, Friedman and Schwartz later characterize moral suasion as the Federal Reserve's "traditional confession of impotence" (p. …

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