The Bank Lending Channel and Monetary Policy Rules: Evidence from European Banks

There exist two main channels of the monetary transmission mechanism: the interest rate and the bank lending channel. This paper focuses on the latter, which is based on the central bank’s actions that affect loan supply and real spending. The supply of loans depends on the monetary policy indicator, which, in most studies, is the real short-term interest rate. The question investigated in this paper is how the operation of the bank lending channel changes when this short-term indicator is allowed to be endogenously determined by the target rate the central bank sets through a monetary rule. We examine the effect that a rule has on the bank lending channel in European banking institutions spanning the period 1999–2009. The expectations concerning inflation and output affect the decision of the central bank for the target rate, which, in turn, affect private sector’s expectations —commercial banks— by altering their loan supply.