Bank Lending and the Transmission of ~~v~onetary Policy

A resurgence of interest in the role of banks in the transmission of monetary policy has resulted in a spate of theoretical and empirical studies. These studies have established that, under certain conditions, the traditional transmission mechanism for monetary policy ("the money view") may be augmented through changes in the supply of bank loans ("the lending view"). Because both the money view and the lending view operate through the banking sector, the health of the banking system, insofar as it affects bank behavior, is an important factor in the transmission of monetary policy. It affects both the nature and the size of bank responses to shifts in monetary policy, with particular relevance for the bank lending channel. The traditional description of monetary policy generally emphasizes the reserve requirement constraint on banks. In this story, banks are an important link in the transmission of monetary policy because changes in bank reserves influence the quantity of reservable deposits held by banks. Because banks rarely hold significant excess reserves, the resel~ce requirement constraint typically is considered to be binding at all times. However, a second constraint on banks, the capital constraint, may be more important in accounting for the variability in the magnitude of the effect of monetary policy over time. The extent to which a capital constraint is binding, unlike the reserve requirement, is likely to vary