Publication of the week:

PROFESSOR GEOFFREY WOOD

Monday 1 June 2009

Alistair Milne & Geoffrey Wood, The bank lending channel reconsidered (Helsinki: Bank of Finland Research Discussion Papers 2, 2009). 68 pp. ISBN: 978-952-462-484-8 (Printed publication), 978-952-462-485-5 (Web publication).

It has been widely accepted that constraints on the wholesale funding of bank balance sheets amplify the transmission of monetary policy through what is called the 'bank lending channel'. The authors show that the effect of such bank balance sheet constraints on monetary transmission is in fact theoretically ambiguous, with the prior expectation, based on standard theoretical models of household and corporate portfolios, that the bank lending channel attenuates monetary policy transmission.

The authors examine macroeconomic data for the G8 countries and find no evidence that banking sector deposits respond negatively and more than lending to tightening of monetary policy, as the accepted view of the bank lending channel requires. The overall picture is mixed, but these data generally suggest that deposits fluctuate procyclically and somewhat less over the business cycle than bank lending, and that total bank deposits, unlike bank lending, show little direct response to changes in interest rates. This suggests it is very unlikely that the bank lending channel amplifies monetary policy. The paper has thus corrected a misunderstanding about the role of banks in monetary policy transmission that has persisted in the literature for some two decades

The full text of this discussion paper is available from the Bank of Finland website (external link).

Geoffrey Wood is Professor of Economics at Cass Business School and Professor of Monetary Economics at the University of Buckingham, where he teaches on the undergraduate Economics programme and the MA in Global Affairs.