The Bank Lending Channel of Monetary Policy Transmission: Evidence from a Model of Bank Behavior That Incorporates Long-Term Customer Relationships

Abstract

I test for the existence of a bank lending channel of monetary policy transmission. I identify bank lending channel effects with a simple model of bank behavior incorporating long-term customer relationships. The model suggests that when a large fraction of bank assets is held in loans, contractionary monetary policy shocks are more likely to cause a cutback in bank lending, in turn reducing real economic activity. This implication of the model is supported in the data. I conduct a "horse race" between the bank lending channel and two alternative non-user-cost-of-capital channels of monetary transmission. The bank lending channel is the strongest of the three. The ability of the fraction of bank assets held in loans to predict how the strength of monetary policy transmission varies over time should be of interest to both theorists and forecasters of business cycles.