Credit frictions and the bank lending channel

Monetary policy decisions are transmitted into the economy through many channels, one of which is the bank lending channel. This paper focuses on this channel, which is based on the central bank’s actions that affect loan supply and real spending. The main variable that affects bank lending is the monetary policy indicator, proxied by the real short-term interest rate. The question examined in this paper is whether there have been any changes in the operation of the bank lending, when disturbances, such as those of recent crisis, occur and whether its operation can be modeled in a manner that better conforms to current institutional realities. There has been observed the necessity to take into consideration changes in financial conditions. The recent literature on macroeconomic analysis and monetary policy takes into account credit frictions and investigates monetary implications. Taylor (2008) has proposed that the Taylor rule should be modified and incorporate credit spreads. Credit frictions, therefore, is an important indicator of the financial situation, since their changes affect the setting of the central bank rate. This rate is a crucial variable, the impact of which is apparent to lending and real spending according to the literature of the bank lending channel. But since variation in credit spreads indicates that there are disruptions in the financial system, they should be incorporated into the model for the estimation of the bank lending channel. These spreads are present between the interest rate available to savers and borrowers and, thus, our goal here is to investigate the effect of such a model that incorporates certain credit frictions for the case of selected European countries.