Monetary Policy and Bank Lending in the Euro Area: Is There a Stock Market Channel or an Interest Rate Channel?

Abstract

In this paper I compare a traditional demand oriented model of bank lending with its focus on short-term interest rates in the money market, to a non-traditional capital budgeting model of bank lending based on movements in share valuations for the Euro area. Using non-nested hypothesis tests, omitted variables tests, and Granger Causality tests, I reject the traditional demand oriented model of bank lending and fail to reject the capital budgeting model of bank lending for Monetary Financial Institutions in the Euro area. Even though Europe is a bank-based financial system, it appears the stock market plays a key role in the lending decisions of banks and the allocation of capital in Europe. One possible implication of this research is that central banks should try and stabilize the stock market in order to stabilize bank lending in Europe.