Corporate Finance and the Monetary Transmission Mechanism

Abstract

We analyze the transmission effects of monetary policy in a general equilibrium model of the financial sector, with bank lending and securities markets. Bank lending is constrained by capital adequacy requirements, and asymmetric information adds a cost to outside bank equity capital. In our model, monetary policy does not affect bank lending through changes in bank liquidity; rather, it operates through changes in the spread of bank loans over corporate bonds, which induce changes in the aggregate composition of financing by firms, and in banks’ equity-capital base. The model produces multiple equilibria, one of which displays all the features of a ‘‘credit crunch.’’ This article is concerned with the monetary transmission mechanism through the financial sector, in particular the banking sector and securities markets. Specifically, it analyzes the effects of open-market operations on bank lending and securities issues in a real economy. By building on recent advances in the microeconomics of banking, it provides some underpinnings for the ‘‘credit view’’ of monetary policy, which, in its simplest form, relies on an exogenously assumed limited substitutability between bank loans and bonds. The macroeconomics literature distinguishes between the ‘‘money view’’ and ‘‘credit view’’ of monetary policy transmission [Bernanke and Blinder (1988, 1992)]. The money view takes bonds and loans to be perfect substitutes and only allows for the effects of monetary policy on aggregate investment, consumption, and savings through changes in interest rates. The credit view allows for an additional effect on investment and economic activity operating through bank credit supply