 Monetary Policy and the Credit Rationing Effects of LiquidityNo 2601, Economics Discussion Papers from Department of Economics, The University of St Andrews Business School Abstract: This paper studies monetary policy in a New Keynesian economy with frictional bank lending, rationalising evidence that lending conditions can remain tight despite liquidity injections. The model features a policy trade-off in which increases in banking sector liquidity can incentivise more lending by lowering the overnight rate and the marginal cost of funds, but can also incentivise less lending by compressing bank margins as interest rates approach the policy floor, worsening adverse selection and credit rationing. As a result, quantitative easing can exert a contractionary effect when the economy is away from the effective lower bound, with outcomes depending on borrower risk and the size of the programme. However, both channels raise inflation expectations, and so liquidity policies are always expansionary at the lower bound. Optimal policy features a deflation bias under credit rationing, while commitment to future accommodation eases current credit conditions and implies gradualism in quantitative tightening. Keywords: Monetary policy; quantitative easing; small business lending; credit rationing; bank liquidity (search for similar items in EconPapers) Downloads: (external link) Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: https://EconPapers.repec.org/RePEc:san:econdp:2601 Access Statistics for this paper More papers in Economics Discussion Papers from Department of Economics, The University of St Andrews Business School Department of Economics, Castlecliffe, The Scores, St Andrews, KY16 9AZ. Contact information at EDIRC. |
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