Monetary Economics

Bank Lending and Monetary Policy : The Case for Short-Term Interest Rates

Introduction

Money , and the way it moves , determines a country 's economic health in terms of its availability and the costs involved in maintaining its value in the market . The monetary policy , usually determined by a central bank , is implemented in three ways : open market operations discount window lending and reserve requirements (Rudebusch 1997

The role of depository banks in monetary policy is in the form of discounted loans that the depository banks in turn lend out to its depositors

or clients as housing loans , car loans , business loans , etc Depository institutions are also required to have a certain amount in the reserves of the central bank held against the deposits of the institution 's clients (Rudebusch 1997

This focuses on bank lending policies as an indicator of whether monetary policy is tight or easy , and the rationale behind limiting monetary policy strategy to short-term interest rates

Bank lending as an indicator of policy strategy

To fully understand the implications of bank lending policies on tight or easy monetary policy , a of bank lending policies monetary policy , tight monetary policy and easy monetary policy will first be discussed

A bank 's lending policy is based mainly on a credit scoring system which is the determinant factor in the approval or rejection of a loan The main purpose of said credit scoring is to ensure that the banks will have the least possible risk if it decides to approve a loan . This is why credit scoring systems are primarily based on data of prior approved loans and rarely takes into account reasons or criteria for the rejected loans (Jacobson and Roszbach 2001 ) It should be noted that the interest rates on the loans have some bearing on this system since the

Monetary policy is a means of managing the supply of money by a financial institution in to achieve certain goals set by the institution . By financial institutions we refer mostly to central banks of governments . Common goals that monetary policies address are spurring economic growth , curbing inflation , and reducing unemployment

These central banks are tasked with managing their respective government 's supply of money . The plans they implement in to manage this and in to achieve their targets set by their respective governments is the monetary policy

Monetary policy is said to be easy ' or accommodative ' when the policy is designed to increase the money in circulation (money in the economy . This is achieved by creating an environment that aims to encourage borrowing of money . The method for creating such an environment is by lowering interest rates . Aside from encouraging the borrowing of money , lowering interest rates also has the effect of lessening money on savings . This also contributes to the increase in money in circulation

Generally speaking , an easy monetary policy is adopted by central banks when the objective is to stimulate economic growth . It is also traditionally adopted to combat unemployment during...