The Bank Lending Channel and Monetary Rules

The monetary transmission mechanism is important for understanding the manner monetary policy affects the economy. There are two main channels of thsi mechanism: the interest rate and the credit channel. The focus of this paper is on the latter and specifically on the bank lending channel, the operation of which is based on the actions of the central bank that affect loan supply and real spending. The supply of loans depends on the monetary policy indicator, which, in most studies, is the real short-term interest rate. The question investigated in this paper is how the operation of the bank lending channel is affected when this short-term interest rate is replaced by the target rate that the central bank sets through an interest rate rule. Specifically, we examine the effect that a rule has on the bank lending channel in 6 European countries over the period 1995-2008. The expectations concerning inflation and output affect the decision of the central bank for the target rate. therefore, since the monetary policy indicator alters, commercial banks react to this change by rearranging the supply of loans. In other words, using an interest rate rule as a policy indicator affects the operation of the bank lending channel, since the monetary policy has an impact on the economy, through the policy actions and announcements that give rise to private sector's expectations - commercial banks - which, in turn, alter their supply of loans.