Pii: S1059-0560(99)00017-9

When the representative bank’s backward-bending loan supply curve peaks at the profitmaximizing loan rate, credit rationing could exist as an equilibrium phenomenon and the equilibrium interest rate in the loan market is subject to upward rigidity. With the loan-market setting as micro-foundation for investment, this paper further develops a macro model of a small open economy under the regime of fixed exchange rates with perfect capital mobility in the bond market and imperfect asset substitutability between bonds and loans. In spite of whether there exists credit rationing, a change in money supply shifts the IS as well as LM curves; the credit-driven adjustment in transaction demand for money lessens the disequilibrium pressure on the money and foreign exchange markets so that the offset coefficient of open market operation is less than one. The stronger the credit channel is, the more legacy of monetary policy it can preserve as desired. In particular, monetary autonomy tends to be less impaired under the credit-rationing regime than under the market-clearing regime.  1999 Elsevier Science Inc. All rights reserved.