DFYIF~MAY/JUNE 1Q95

Stephen C. Cetcheth is professor of economics at Ohio State University. The author thanks Margaret Mory McConnell for able researchassistance, ond Allen Berger, Ben Bernanke, Anil Koshyap, Nelson Mark, Alan Viard and the participants at the conference for comments andsuggestions. The author also expresses gratitude to the National Stience Foundation and the Federal Reserve Bank of Cleveland for financialand research support.

DistinguishingTheories of theMonetaryTransmissionMechanism

Stephen G. Cecchetti

yai raditional studies of monetary policy’s• impact on the real economy have

I focused on its aggregate effects.Beginning with Friedman and Schwartz(1963), modern empirical research in mone-tary economics emphasizes the ability of pol-icy to stabilize the macroeconomy. But casualobservation suggests that business cycles

have distributional implications as well, Oneway of casting the debate over the relativeimportance of different channels of monetarypolicy transmission is to ask if these distrib-utional effects are sufficiently important to

warrant close scrutinyThe point can be understood clearly by

analogy with business cycle research moregenerally Ifrecessions were characterized by

a proportionate reduction of income acrossthe entire employed population—for example,everyone worked 39 rather than 40 hours

per week for a few quarters—then economistswould pay substantially less attention tocycles. It is the allocation of the burden orbenefit of fluctuations, with some individualsfacing much larger costs than others, that isof concern, There are two ways for an econ-omist to address this problem. The first is to

attempt to stabilize the aggregate economy,the traditional focus of policy-orientedmacroeconomics, The second is to ask whythe market does not provide some formof insurance.

The recent debate over the nature of themonetary transmission mechanism can be

thought of in similar terms. According tothe original textbook IS-LM view of moneychanges in policy are important only insofaras they affect aggregate outcomes. Only thefluctuation in total investment is importantsince policies only affect the required rate ofreturn on new investment projects, and so itis only the least profitable projects (economy-wide) that are no longer funded. But sincethe most profitable projects continue to beundertaken, there are no direct efficiencylosses associated with the distributional

aspects of the policy-induced interestrate increase,

In contrast, the “lending” view focuseson the distributional consequences of mone-tary pohcy actions. By emphasizing a combi-nation of capital market imperfections andportfolio balance effects based on imperfect

asset substitutability, this alternative theorysuggests the possibility that the policy’s inci-dence may differ substantially across agentsin the economy Furthermore, the policy’simpact has to do with characteristics of theindividuals that are unrelated to the inherentcreditworthiness of the investment projects.An entrepreneur may be deemed unworthyof credit simply because of a currently lownet worth, regardless of the social return tothe project being proposed. It is importantto understand whether the investment

declines created by monetary policy shiftshave these repercussions,n

In this essay, I examine how one mightdetermine whether the cross-sectional effects

of monetary policy are quantitatively impor-tant. My goal is to provide a critical evaluationof the major contributions to the literaturethus far. The discussion proceeds in threesteps. I start in the first section with adescription of a general framework thatencompasses all views of the transmissionmechanism as special cases, thereby high-hghting the distinctions. In the second section,I begin a review of the empirical evidencewith an assessment of how researchers typi-cally measure monetary policy shifts, Thefollowing two sections examine the methods

The francial accelerator, ir whichthe impact ea ianestmeet of smallinterest changes is mognified bybalance sheet effects, is (Iso animportant part of many discussionsof the lending niew.

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2 See lngersall (1987) fore con

plete descf ptian of this problem.

[allowing the treditnnal francialeconomics approach, I bane avoirhddiscussing demand and supplyexplicitly. Irstead, the onsetdemands ore derined Irom the ideaof arbitrage relaflnnships among nilof tIne assets.

These include the limited parficipa-tan models based er Lucas(1990). See the survey byFexrst(1993), aswell as the summary inChdstiann and lichenhoaml1992L

used for differentiating between the theories.Studies fall into two broad categoriesdepending on whether they use aggregate ordisaggregate data. The third section discussesthe aggregate data, while the fourth sectiondescribes the use of disaggregate data, Aconclusion follows.

MONfl4Ufl( POUcYT.TWBIRY

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One way of posing the fundamentalquestion associated with understanding themonetary transmission mechanism is to askhow seemingly trivial changes in the supplyof an outside asset can create large shifts inthe gross quantity of assets that are in zeronet supply I-low is it that small movementsin the monetary base (or nonborrowed

reserves) translate into large changes indemand deposits, loans, bonds and other

securities, thereby affecting aggregate invest-ment and output?

The various answers no this puzzle canbe understood within the framework origi-nally proposed by Brainard and Tobin (1963).Their paradigm emphasizes the effects ofmonetary policy on investor portfolios, and

is easy to present using the insights fromFama’s (1980) seminal paper on the relation-ship between financial intermediation and

central banks.Fama’s view of financial intermediaries

is the limit of the current type of financialinnovation, because it involves the virtualelimination of banks as depository institu-tions. The setup focuses on an investor’sportfolio problem in which an individual

must choose which assets to hold given thelevel of real wealth. Labeling the portfolioweight on asset i as w,, and total wealth as

W then the holding of asset, i—the assetdemand—is just X, = w1W

In general, the investor is dividingwealth among real assets—real estate, equityand bonds—and outside money Each assethas stochastic return, ~,, with expectation ~

and the vector of asset returns,~,has acovariance structure F. Given autility func-tion, as well as a process for consumption, it is

possible to compute the utility maximizingportfolio weights. These will depend on themean and variance of the returns.~and F,the moments of the consumption process,call these p.r, and a vector of taste parametersthat I will label 4, and assume to be constants.

The utility maximizing asset demands can beexpressed as = w*,(’~,fl ~

This representation makes clear than

asset demands can change for two reasons.Changes in either the returns process (~,For macroeconomic quantities (~,W) willaffect the XIs,3

At the most abstract level, financialintennediaries exist to carry out two functions.First, they execute instructions to changeportfolio weights. That is, following a changein one or all of the stochastic processes drivingconsumption, wealth or returns, the interme-diary will adjust investors’ portfolios so thatthey continue to maximize utility In addition,if one investor wishes to transfer some wealthto another for some reason, the intermediarywill effect the transaction.

What is monetary policy in this stylizedsetup? For policy to even exist, some gov-ernment authority, such as a central bank,must be the monopoly supplier of a nominallydenominated asset that is imperfectly substi-tutable with all other assets. I will call thisasset “outside money” In the current envi-ronment, it is the monetary base. There is asubstantial literature on how the demand foroutside money arises endogenously in the

context of the type of environment I havejust described.4 But in addition, as Famaemphasizes, there may be legal requirementsthat force agents to use this particular asset

for certain transactions. Reserve requirementsand the use of reserves for certain types ofhank clearings are examples.

Within this stylized setup, apolicy action

is a change in the nominal supply of outsidemoney For such a change to have any

effects at all, (1) the central hank controlsthe supply of an asset that is both in demandand for which there is no perfect substitute,

and (2) prices must fail to adjust fully andinstantaneously Otherwise, a change in thenominal quantity of outside money cannothave any impact on the real interest rate, andwill have no real effects. But, assuming that

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the policymaker can change the real return

on the asset that is monopolistically supplied,investors’ portfolio weights must adjust inresponse to a policy change.

The view of financial intermediaries thatis implicit in this description serves to high-light the Brainard and Tobin (1963) insight

that monetary pohcy can be understood byfocusing solely on the endogenous responseof investor portfolios. Understanding the

transmission mechanism requires a charac-terization of how asset holdings change inresponse to policy actions.

Second, even though there need be nobanks as we know them, there will surely beintermediaries that perform the service ofmaking small business loans. The agencycosts and monitoring problems associatedwith this type of debt will still exist, and spe-

cialists in evaluation will emerge. While theywill have such loans as assets, they mostlikely will not have bank deposits as liabihties.Such entities will be brokers, and the loanswill he bundled and securitized,

With this as background, it is nowpossible to sketch the two major views of themonetary transmission mechanism. Thereare a number of excellent surveys of thesetheories, including Bernanke (1993a),Gertler and Gilchrist (1993), Kashyapand Stein (l994a) and Hubbard (1995).As a result, I will be relatively brief inmy descriptions.

flflE MON.EY VIEVI

The first theory commonly labeledthe money view, is based on the notion thatreductions in the quantity of outside money

raise real rates of return,5 This, in turn,reduces investment because fewer profitableprojects are available at higher required ratesof return—this is a movenuent along a fixedmarginal efficiency of investment schedule.The less substitutable outside money is

for other assets, the larger the interestrate changes.

There is no real need to discuss banksin this context, In fact, there is no reasonto distinguish any of the “other” assets in

investors’ portfolios. In terms of the simpleportfolio model, the money view implies

that the shift in the w~sfor all of the assets

excluding outside money are equal.An important imphcation of this tradi-

tional model of the transmission mechanisminvolves the incidence of the investmentdecline. Since there are no externalities ormarket imperfections, it is only the least

socially productive projects that go unfunded.The capital stock is marginally lower. But,given that a decline is going to occur, theallocation of the decline across sectors issocially efficient.

This theory actually points to a measure

of money that is rarely studied, Most empiri-cal investigations of monetary policy trans-mission focus on M2, but the logic of the

portfolio view suggests that the monetarybase is more appropriate. It is also worthpointing out that investigators have foundit extremely difficult to measure economicallysignificant responses of either fixed or inven-tory investment to changes in interest ratesthat are plausibly the result of policy shifts,In fact, most of the evidence that is interpretedas supporting the money view is actually evi-dence that fails to support the lending view.

THE LIEHDff NO ViEW:BALANCE ~.w~rr:._;EPECTS

The second theory of monetary trans-mission is the lending view,6 It has two parts,one that does not require introduction ofassets such as hank loans, and one that does.The first is sometimes referred to as the broadlending channel, or financial accelerator, andemphasizes the innpact of policy changes onthe balance sheets of borrowers. It hearssubstantial similarity to the mechanism oper-ating in the money view, because it involvesthe impact of changes in th~real interest rateon investment.

According to this view, there are creditmarket imperfections that make the calcula-tion of the marginal efficiency of investment

schedule more complex. Due to informationasymmetries and moral hazard problems, aswell as bankruptcy laws, the state of a firm’sbalance sheet has implications for its abilityto obtain external finance. Policy-induced

increases in interest rates (which are both realand nominal) can cause a deterioration in

lerminalogy has the potenflnl tocreate confusion here. Ihave cho-sen the troditianal term for thistextbook IS-tM ar ‘narrow’ moneynew. Ida not mean to imply thatthis is the ‘monetaist’ view af thetransmission mechanism.

follaw Kashyap and Stein’s

11 994al terminology rather thanthe more common credit xiew toemphasize the importance of loansin the erarsmissian mechanism.lerranke and Gerfier (1989,19901 pravide the original thearet’cal underpinnings for this view.

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lernunke, Gertler and Gilchriso

(1994) refer to this nsa financioloccebruro -sinceitcoases smallchanges in interest rates no havepotentially large effects on invest-ment and output.

°ltmaybe particularly difficult ox dis-tagaish these effects from thosethat arise from oaryiag cyclicnlity ofdifferentfirms’ soles and profitability.

o See James (1987) for a discussionof the oniqueness of bark loans.

mx With nominal rigidity, a decrease in

outside money reduces the pricelevel slowly, and so the real returnto holding money increases. Thischannel of transmission requiresthat inoestors shift awayfrom loansin response.

Koshyap and Stein (1994b) point

out that large banks car issue (Osin away that insulates their halence sheets from contractor indeposits, hat small barks cannot.So long assmall banks are animportant source xl funds far samehnnk’dependert firms, there willsoIl be a honk lending channel. Inother wards, for honk lending to bean important part of the traesmis-sian mechanism, credit marketimpemfectons mest be impartaetfar honks.

the firm’snet worth, by both reducing expectedfuture sales and increasing the real value ofnominally denominated debt, With lower networth, thefirm is less creditworthy because ithas an increased incentive to misrepresentthe riskiness of potential projects. Asa result,potential lenders will increase the risk pre-mium they require when making a loan. Theasymmetry of information makes internalfinance of new investment projects cheaperthan external finance.

The balance sheet effects imply that theshape of the marginal efficiency of investmentcurve is itself a function of the debt-equityratio in the economy and can be affected bymonetary policy7 In terms of a simple text-book analysis, policy moves both the IS andthe LM curves. For a given change in therateof return on outside money (which may bethe riskless rate), a lender is less willing tofinance a given investment the more debt apotential borrower has. This points to twoclear distinctions between the money andthe lending views—the latter stresses boththe distributional impact of monetary policyand explains how seemingly small changes

in interest rates can have a large impact oninvestment (the financial accelerator).

Returning to the portfolio choice model,

the presence of credit market imperfectionsmeans that policy affects the covariancestructure of asset returns, As a result, thew7s will shift differentially in response tomonetary tightening as the perceived riski-ness of debt issued by firms with currently

high debt-equity ratios will increase relativeto that of others.8

The second mechanism articulated by

proponents of the lending channel can bedescribed by dividing the “other” assets ininvestors’ portfolios into at least three cate-gories: outside money, “loans” and all theothers. Next, assume that there are firms forwhich loans are the only source of externalfunds—some firms cannot issue securities.0

Depending on the solution to the portfolioallocation problem, a policy action maydirectly change both the interest rate and

the quantity of loans, It is not necessary tohave a specific institutional framework inmind to understand this, Instead, it occurswhenever loans and outside money arecomplements in investor portfolios; that is,whenever the portfolio weight on loans is anegative function of the return on outsidemoney for given means and covariances ofother asset returns.no

The argument has two clear parts. First,there are borrowers who cannot financenew projects except through loans, andsecond, policy changes have a direct effecton loan supply Consequently the mostimportant impact of a policy innovation iscross-sectional, as it affects the quantity ofloans to loan-dependent borrowers.

Most of the literature on the lending viewfocuses on the implications of this mechanismin a world in which banks are the only sourceof loans and whose habilities are largelyreservable deposits. In this case, areductionin the quantity of reserves forces a reductionin the level of deposits, which must be

matched by a fall in loans. The resultingchange in the interest rate on outside moneywill depend on access to close bank depositsubstitutes. But the contraction in bank bal-ance sheets reduces the level of loans. Lowerlevels of bank loans will only have an impact

on the real economy insofar as there arefirms without an alternative source of

investment funds.As a theoretical matter, it is not necessary

to focus narrowly on contemporary banks intrying to understand the different possibleways in which policy actions have real effects.As I have emphasized, bank responses tochanges in the quantity of reserves are justone mechanism that can lead to a comple-mentarity between outside money and loans.Aspointed out by Romer and Romer (1990),

to the extent that there exist ready substitutesin bank portfohos for reservable deposits such

as CDs, this specific channel could he weakto nonexistent,mn But it remains a real possi-bility that the optimal response of investors

to a policy contraction would be to reducethe quantity of loans in their portfolios.

The portfolio choice model also helps tomake clear that the manner in which policyactions translate into loan changes need not

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be a result of loan rationing, although itmaynz As Stiglitz and Weiss (1981) originally

pointed out, a form of rationing may arise inequilibrium as a consequence of adverseselection, But the presence of a lendingchannel does not require that there beborrowers willing to take on debt at the cur-rent price who are not given loans. It ariseswhen there are firms which do not haveequivalent alternative sources of investmentfunds and loans are imperfect substitutes ininvestors’ portfolios.

Obviously, the central bank can takeexplicit actions directed at controlling thequantity of loans. Again, lowering the levelof loans will have a differential impact thatdepends on access to financing substitutes.But the mechanism by which explicit credit

controls influence the real economy is adifferent question.tm°

“54cr

645 SSxc~xx5 54554 56.

;wo VV~Ts OTVET~.CONBiiX lOTIONS

Distinguishing between these two viewsis difficult because contractionary monetarypolicy actions have two consequences,regardless of the relative importance of themoney and lending mechanisms. It both

lowers current real wealth and changes theportfolio weights.nx

Assuming that there are real effects,contractionary actions will reduce futureoutput and lower current real wealth, reducing

the demand for all assets. In the context ofstandard discussions of the transmissionmechanism, this is thereduction in investment

demand that arises from a cyclical downturn.8

The second effect of policy is to changethe mean and covariance of expected assetreturns, This changes the w55’s. In the simplest

case in which there are two assets, outsidemoney and everything else, the increase inthe return on outside money will reduce the

demand for everything else. This is a reduc-tion in real investment.

The lending view implies that thechange in portfolio weights is more complexand in an important way There may besome combination of balance sheet and loan

supply effects.

This immediately suggests that lookingat aggregates for evidence of the right degreeof imperfect substitutability or timing ofchanges may be very difficult, What seemspromising is to focus on the other distinctionbetween the two views—the lending view’sassumption that some firms are dependenton loans for financing.

In addition to differences stemmingfrom the relative importance of shifts in loandemand and loan supply the lending viewalso predicts cross-sectional differences arisingfrom balance sheet considerations, These arealso likely to be testable. In particular, itmay be possible to observe whether, giventhe quality of potential investment projects,firms with higher net worth are more likelyto obtain external funding. Again, the majorimplications are cross-sectional.

EMPIRICAL t

Before discussing any empirical exami-nation of the monetary transmission mecha-nism, two questions must be addressed.First, do nominal shocks in fact have realeffects? Unless monetary policy influencesthe real economy it seems pointless to studythe way in which policy changes work.Second, how can we measure monetarypolicy? In order to calculate the impact ofmonetary policy we need a quantitativemeasure that can reliably be associated withpolicy changes.

Here I take up each of these issues. Inthe following section, 1 will weigh the evi-

dence on the real effects of money This isfollowed by a discussion of ways in whichrecent studies have attempted to identify

monetary shocks.

%C OTtL c-ntcCLil c~54t45444554~5r cr54544944— 55’5/~~ <‘<455 ~56 4—

Modern investigation of the impact of

money on real economic activity began withFriedman and Schwartz (1963). In manyways, this is still the most powerful evidence

in support of the claim that monetary policyplays an important role in aggregate fluctua-tions. Through an examination that spanned

52 Since there must be firms than ore

loan-dependent, there is sf11 someform of rationing in the securitymarket.

xx See tamer and Ramer (1993) for

a concise discussion of recentepisodes in which the FederalReserve has attempted na chungethe compositon of honk holoncesheets through means other thansnundard policy actions.

H The change in portfolio weights can

rise either from any combinationof a charge in the return on theoetside asset, a change in thecovariance structrre xf returns, orshift in the consumption process.

~In general equilibrium, there is anoffsetting effect that arises fromthe increase in the ietereso rate. All

other things equal, this wouldincrease saving and thereforeinvestment. lx? we can be faidyconfident that so long as maneoarypolicy ighteniag can caese a reces-sian, the impact of the income andwealth declines will he largeenough that inoestment will foil.

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56 The equinalent apen economy

observation is that in small openeconomies, enchorge rates move inresponse to changes in policy.

xx Boschen and Mills (19921 describe

a related technique.

~°See Hamilton 11994) for a completedescriptor af the methodalogy.

~The enact measrres and sample fol-

low those of Krshyap and Stein(1 994rl, who kindly supplied thedata.

numerous monetary regimes, they argue thatapparently exogenous monetary policy actionspreceded output movements.

Recent researchers use more sophisticatedstatistical tools to study the correlations

between money and income. This “money-income causality” literature is largely inconclu-sive, because it fails to establish convincinglyeither that money “caused” output or the

reverse. In the end, the tests simply establishwhether measures of moneyforecast output,not whether there is causation. Given that

outside money—the monetary base—is lessthan 10 percdnt of the size of M2, it is notsurprising that economists find the simul-

taneity problems inherent in the questiontoo daunting and give up.

Two pieces of evidence seem reasonably

persuasive in making the case that moneymatters. First, the Federal Reserve seems to

he able to change the federal funds rate vir-tually without warning. (I am not arguingthat this is necessarily a good idea, just thatit is possible.) In the very short run, these

nominal interest rate changes cannot beassociated with changes in inflationaryexpectations, and so they must representreal interest rate movements, Such realinterest rate changes almost surely have animpact on real resource allocations,ra

The second piece of evidence comesfrom the examination of the neutrahty ofmoney in Cecchetti (1986, 1987). In those

papers, I establish that output growth issignificantly correlated with money growthat lags of up to 10 years! There are several

possible interpretations of these findings,but they strongly suggest that monetaryshocks have something to do with aggregatereal fluctuations.

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TO ~t’opi’iawv POliCYIt stands to reason that before one can

study the monetary transmission mecha-nism, it is necessary to identify monetaryshocks. A number of authors have argued

convincingly that policy disturbances cannotbe gauged by examining movements in themonetary aggregates. The reason is that thevariance in the innovations to broad measures

of money are a combination of endogenous

responses to real shocks (King and Plosser,1984) and shifts in money demand

(Bernanke and Blinder, 1992).There have been two reactions to the

fact that monetary aggregates provide littleinsight into policy actions. Both begin bylooking at the functioning of the FederalReserve and examining how policy is actually

formulated. The first, due to Bernanke andBlinder (1992), note that the federal fundsrate is the actual policy instrument that is usedon a day-to-day basis, This suggests thatinnovations to the federal funds rate are likelyto reflect, at least in part, policy disturbances.The main justification for their conclusioncomes from examining the instittitions of howmonetary policy is carried out.

Romer and Romer (1989) suggest asecond method. By reading the minutes ofthe Federal Open Market Committee (FOMC)meetings, they have constructed aseries ofdates on which they believe policybecame contractionary.nT

:55

To understand the shortcomings of thesetwo approaches, I will describe how each isused. In the first, researchers begin by specify-ing a vector autoregression. For thepurposesof the example, I will use theformulation inBernanke and Blinder’s (1992) Section IVThey employ a six-variable specification withthe total civilian unemployment rate, the log ofthe CPI, the federal funds rate, and the log ofthree bank balance sheet measures, all in realterms: deposits, securities and loans. Theassumption is that the federal funds rate is a‘policy” variable, and so it is unaffected by allother contemporaneous innovations,mn

Following Bernanke and Blinder, I esti-mate the VARwith six lags using seasonallyadjusted monthly datumO Figures 1 and 2plot some interesting results from this VAR.The first figure shows the estimated residualsfrom the federal funds rate equation. Thesolid vertical lines are National Bureau ofEconomic Research (NBER) reference cyclepeaks and troughs, while the dashed verticallines are the Romer and Romer dates, intend-ed to indicate the onset of contractionary

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II E~I[t~MAY/JUNE 199$

monetary policy episodes.This series looks extremely noisy and

it is hard to see how it could represent policychanges. The 1979-82 period is the only

one with large positive or negative values.Although it is surely the case that there areunanticipated policy changes both when theFederal Reserve acts and when it does not,

one would expect small normal shocks withoccasional spikes. If decisions are really thisrandom, there is something fundamentally

wrong with the policymaking apparatus.Furthermore, since the federal funds rate

itself is the equilibrium price inthe reservesmarket, given technicalities of the way thatmonetary policy is actually carried out, themarket-determined level of the funds rate is

not a policy instrument.20

The second figure shows the response of

the log of the CPI to a positive one percentagepoint innovation in the federal funds rate. Tounderstand how this is computed, begin by

writing the vector autoregression as

Aa)y, =~x’

where AU.) is a matrix of polynomials in thelagoperator L (L’Yx = yr,), y1 is the vectorof variables used in the estimation, and C 15

mean zero independent (but potentially het-

eroskedastic) error. The first step is to esti-mate the reduced form version of equation 1

by assuming that no contemporaneous vari-ables appear on the right-hand side of anyequations (A(0) = I), This results in an esti-mate A(L) alongwith an estimated covariance

matrix for the coefficient estimates—callthis (2. The impulse response functions

are obtained by inverting the estimated lagpolynomial B(L) =

But the point estimate of the impulseresponse function is not really enough to

allow us to reach solid conclusions, It is alsoimportant to construct confidence intervals

for the estimates. There are two ways to dothis. The first involves the technique thathas been called Monte Carlo Integration.This is a Bayesian procedure that involvespresuming that the distribution of the vectorof errors in equation 1—the c’s—is i.i.d.normal.22 To avoid making such stringentassumptions, I choose to estimate confidencebands using an alternative technique grounded

Esfimated Innovations to the FederalFunds RatesPercentage points

34<4’

21hi

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-4

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65 68 80

in classical statistics.The delta method is the simple proce-

dure that comes from noting that if the esti-mates of the coefficients in lag polynomialsare asymptotically nonnally distributed, thenany well-behaved function of these parameterswill also be asymptotically normally distrib-uted. Stacking all of the parameters in A(L)and calling the result 0, then

IT(o—o)~N(0,O).

It follows that any function of theseparameters [(0)—for example, the impulseresponse function—will be asymptoticallynormally distributed,

83 1989

20 (his entire discnssior ignores the

possibility that ont)cipa?Smona-tery policy matters— somethingthan researchers should considerbringing into the discussion.

< A simple way to calculate the veeInn moving-average form of equa-tion I is to constmct the compommr form of the VAR as described inSargent (198/). This is also dis-cussed in Hamilton (1994).

xx See loon (1990).

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—S1959 62 71 74 77 86

Response of the Log CPI to a Change inthe Federal Funds Rate

0 2 4 6 8 10 12 14Horizon in months

16 18 20 22 24

89

DF~IF~MAY/JUNE 1995

13 A test for whether oil of the reae

tons ore jointly zero rejects ot thepercent level for the hrst seven

months, and then fails to rejectThe test for whether all the effectsore zero simnitrreously for oIl 24months foils tu reject with o p-valueof 0./f.

on There is o further reason to niew

this measure of policy with sameskepticism. Because of the lorgenumber of parameters estimated,the regressions are usually orerfit-ted. As a resnlt, they normallyhove very poor oat-of-sample fortcastieg properties.

25 See Friedman (1990) for o discos’

sion of the strategy of using policy-makers’ statements to gange theiractions.

o =~‘S~‘ do’ dO

which can be estimated numericallyThe result plotted in Figure 2 was first

pointed out by Sims and is known as the“price puzzle.” Paradoxically the VAR esti-mates imply that monetary policy contrac-tions lead to price increases! As is clear fromthe estimated standard-error bands, this pricerise is significantly positive for approximatelythe first year After two years, however’, it isnot possible to reject the hypothesis that afunds rate increase has no effect on the pricelevel.2’

The standard conclusion is that the VARis misspecified in some way One strong pos-sibility is that the funds rate is not exogenousin the way that is required for this identifica-tion to be valid, and so these innovations donot accurately reflect policy movements.24

My conclusions may be too harsh for thefollowing reason. AsBen Bernanke pointedout in the conference, the estimated innova-tions are the sum of true policy innovation,policy responses to omitted variables, andmore general specification errors in the VAR.As a result, one would expect them to benoisy Furthermore, as pointed out by AdrianPagan, since one is primarily interested in theimpulse response functions—the impact ofunanticipated policy on output, prices andthe like—then it may be immaterial that theestimated policy innovations are noisy evenif the true innovations arenot.

ffla Kim-er as~sd.R-orrser DatesThe Romer and Romer dates have been

both widely used an4 extensively criticized.2’They suffer from both technical and substan-tive problems. First, they are discrete.Presumably policy changes have both an

intensity and a timing. Ignoring the size ofpolicy changes must have an impact on

results. Second, Romer and Romer choose tofocus their inquiry only on policy contrac-

tions, because they feel that expansions weremore ambiguous. Since most models predictsymmetric responses to positive and negative

monetary innovations, this strategy throwsout information.

But the main issue is the exogeneity

of the policy shifts. It is difficult to believethat the actions of the FOMC, as reported inthe minutes of the meetings, are truly exoge-

nous events, There have been two responsesto this. First, Hoover and Perez (1991) pro-vide a lengthy discussion of why Romer and

Romer’s methods are not compelling in iden-tifying output fluctuations induced by exoge-nous monetary shocks.

Taking a slightly different approach,

Shapiro (1994) examines whether the FOMCis responding to changes in economic condi-

tions, and so there is some reaction functionimplicit in policy He estimates aprobitmodel for the Romer and Romer dates using

measures of inflation and unemployment,both as deviations from a carefully constructedtarget level, as determinants. Figure 3 repro-duces his estimates of the probability of adate, with the vertical lines representing thedates themselves. The unanticipated policy

action is 1 minus the estimated probabilityAs is clear from the figure, several of thedates were largely anticipated, and there

were some periods when policy shifts werethought to be likely and then did not occur.Overall, Shapiro’s results suggest that thestandard interpretation of the dummy vari-ables as exogenous is incorrect to varyingdegrees over time.

There seems to be no way to measure

monetary policy actions that does not raiseserious objections. Given this, it might seem

difficult to see how to proceed with the studyof different theories of the transmissionmechanismn. But the literature proceeds intwo directions. The first uses these measuresdirectly in an attempt to gauge the influenceof policy changes directly The conclusions

of these studies must be viewed with somedegree of skepticism. The alternativeapproach is to note that investment declinesaccount for the major share of output reduc-

tions during recessions. If one is able toshow that the distribution of the contractionin investment is correlated with variables

FEOEEAL RESEEVE BANK OF ST. LOUIS

‘h(j{o]-i[o]) ~N(O,O~),

where

90

II i~IF~MAY/JUNE 1995

related to a firm’s balance sheet and its accessto bank loans, then this strongly suggests theexistence of a lending channel.

r”—’—’-<”- 9~4<5’ 44

5144554.44 M~w4#i4455ttt*5E 44.10*

Numerous studies have used aggregatedata in an attempt to distinguish the channelsof monetary transmission. This literaturecan be divided into three categories: Thefirst looks at the relative forecasting abilityof different quantity aggregates; the secondstudies differences in the timing of theresponse of aggregate quantities to presumedpolicy shocks; and the third examines thebehavior of interest rates.

Before examining the work on quantities,I will discuss the use of interest rate data.2’As is clear from the discussion in the firstsection, the lending view does allow formovements in market interest rates.Furthermore, these movements are in thesame direction as those predicted by themoney view, and their magnitude dependssolely on the degree of substitutabilitybetween outside money and various otherassets. Where the two views differ is in theirpredictions for movements in the interestrate on loans. But since there is currently nosecondary market for these securities, it isimpossible to determine the interest rate onthese loans.2’ This implies that market interestrates are of virtually no use in this exercise.There is no sense in which the behavior ofinterest rates could serve to distinguishbetween the money or lending views.

I now turn to the work on quantities. Inthe following section, 1 examine tests involvingthe relative forecasting ability of tneasures ofmoney and credit. This is followed by a dis-cussion of papers that emphasize aggregatetianing relationships.

55 — r — - so 4’,Ketaame rarecr.sstma .i~a.mtyA number of papers have examined the

ability of different financial aggregates toforecast output (or unemployment) fluctua-tions. Ramey (1993) is a recent example.The main methodology here is to ask whether

measures of credit are informative aboutfuture output movements, once money has

~wssr assassaEstimated Probability of aRomer and Romer Date

(Shapiro prahit model USing hi!lotion and vnemploymnt)

0.6

i’m55’s r5’‘<‘5

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5’S’ 5,5

(‘55 i’ii’i A_____ -~ ~ ~‘/ I~rr’

1953 56 59 62 65 68 71 74 77 80 83 86 89 1992

been taken into account. The problem withthis is that credit is usually just a broadermeasure of money To put it slightly differentlythebalance sheet identity of the bankingsystem implies that bank assets equal bank

liabilities. As Bernanke (1993b) points out,monetary aggregates are a measure of bankhabihties, while credit aggregates are measures

of hank assets. Since these are calculatedslightly differently the)’ will not be identical.But it is these technical measurement differ-

ences that are likely to account for the differ-ences in forecasting ability not anythingabout the transmission mechanism.

More generally the main finding is that

credit lags output. Unfortunately, this tellsus nothing about the transmission mechanism.The aggregate data do show that aggregatecredit is cotantercyciicco!, hut it is easy to findexplanations for this that are consistent with

the lending view. For example, Kiyotaki andMoore (1993) presena a model in which indi-viduals must continue to service credit even

after income falls, and so credit falls afterincome even though it is the fundamentalsource of fluctuations. In the end, it is diffi-

cult no see how aggregate timing relationshipscan tell us anything at all about the way in

which monetary policy affects real activity2’

Aggregate ;Da.sigg ReIatia~rsshipsThe second use of aggregate data has

been to examine the response of various

rEDERAL RESERVE BANK OF ST. LOUIS

0.5

0.4

0.3

0.2

0,1

0

Mirxn, Rower and Weil 11994)

stxdy pre-Worid War II interest

rates in on ottempt to addressthese qnestmrs.

in the presence ml rotioning, thereis tie added cowplicatinr that one‘aoald need observations an theshodonv price for a loom to a bar’rowor who is deemed not to hecreditworthy giver the oconomicennironwent. Obviously, there isno easy way ta irfer such a price.

ox This point is also mode by

Bemnrnke, Gerfier and Gilchnist(1994).

91

H [Yl [~MAY/JUHE 1995

financial quantities to policy innovations.Returning to Bernanke and Blinder (1992),they study whether bank loans and securitiesrespond differently to federal funds rateinnovations.29 The standard methodology isto calculate the impulse responses for thetwo variables and note that they look different.Figure 4 reports the common finding, calcu-lated using the six-variable Bernanke andBlinder VARestimated over the 1959-90sample. In response to a positive 1 percentagepoint innovation in the federal funds rate,the unemployment rate rises by nearly 0.1percentage point after one-and-a-half years,while bank securities fall 0.07 percent andloans decline 0.02 percent. Securities fallboth by a largeramount and more quicklythan loans.

But point estimates of these impulseresponses do not tell the entire story InFigure 5, 1 plot the point estimate and twostandard error bands for the differencebetween the impulse response for loans andsecurities. This allows an explicit test ofwhether these two assets are imperfectly sub-stitutable in response to the shock. The dif-ferences are individually greater than zero inonly a few months, and ajoint test of the first24 months of the impulse response, which isasymptotically distributed as a Chi-squared,has a p-value of 0.70.

My conclusion is that reduced-form vec-tor autoregressions are nearly incapable ofproviding convincing evidence of a differential

impact of federal funds rate innovations onvarious parts of bank balance sheets. Theseresults are based on the estimation of a large

number of parameters with a relatively smallamount of data—this VARhas 237 parametersand 354 data points—and so the estimatesare fairly imprecise.’0

But even if one were to find that theimpulse responses differed significantly this

would only bear on the substitutability of theassets, and not directly on the validity of thelending view, Both the prices and quantitiesof perfect substitutes must have the samestochastic process, and so finding that thisparticular partial correlation is differentwould be evidence of imperfect substitutabil-ity As Bernanke and Blinder (1992) makeclear in discussing their findings, this is anecessary but not a sufficient condition forthe lending view to hold. It is not possible,using reduced-form estimates based onaggregate data alone, to identify whetherbank balance sheet contractions are causedby shifts in loan supply or loan demand.What is needed is a variable that is knownto shift one curve but not the other.

Kashyap, Stein and Wilcox (1993) alsoprovide evidence based on aggregate timing.They compare the response of bank loans tothat of commercial paper issuance followingpolicy innovations. They find that monetarypolicy contractions seem to decrease themix of loans relative to commercial paper.Borrowers that can move away from directbank finance following a tightening appearto do so. Both Friedman and Kuttner (1993),and Oliner and Rudebusch (1993) take issuewith these findings and show that changes inthe mix are due to increases in the amount ofcommercial paper issuance during a recession,but that the quantity of bank loans does not

change. In addition, Oliner and Rudebuschshow that once fia’m size is taken into account,and trade credit is included in the debt of the

small firms, the mix of financing is left unaf-fected by policy changes.

It is worth making an additional point

about the commercial paper market. First,Post (1992) documents that all commercialpaper rated by a rating agency must have a

backup source of liquidity which is generallyabank line of credit or a standby letter of

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Morgan 11992) and Serougin

11991) ore olso eramples of thistype of work.

xx1

have tried two vatants of the

Bemanke and Blinder VAR methodthat might seem promising ways ofaddressing the problem of neasor-ing monetary policy changes. Inthe first, Isabsttemted the fends rateforget us reported in Sellan 11994)far the actual funds rate. This hasvery little impact on the results, asthe fed comes extremely close tohitting the targets. Second, Imodethe alternative extreme assomptionthat the lieds rate itself is exoge-eGos. This has very dramaticeffects an the resnlts, as Bernarke

mad Blinder’s conclusions ore corny-pletely onsvpported. If all move’ments in the funds rote areassnmed to represent evogennaspolicy actions, it woeld be eotreme-ly difficult to claim that loans andsecurities responded differently topolicy shifts.

92

HF~II[~MAY/JUNE ‘995

credit. This means that commercial paper isan indirect liability of banks, albeit one thatis not on their balance sheet. Furthermore,

Calomiris, Himmelberg and Wachtel (1994)suggest that increases in commercial paperissuance are accompanied by an increase in

trade credit. This means that a pohcy con-traction may simply cause a re-shuffling ofcredit by forcing banks to move liabilities off

of their balance sheet such that large firmsissue commercial paper in order to providetrade credit to small firms that would have

otherwise come from banks.

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There is a large empirical literature using

cross-sectional data that is relevant to under-standing the channels of monetary pohcyThese studies fall into groups that separatelyaddress the two parts of the lending view.The first set of papers tries to gauge theimportance of capital market imperfectionson investment, and so is related to the balancesheet effects described in the first section.The second set, which is fairly small, examines

time-series variation in cross-sectional datain an attempt to characterize the distributionaleffects of monetary policy directly I willbriefly describe each of these strategies.

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The literature on capital market imper-fections is an outgrowth of the vast workdone on the detenninants of investment.The general finding in this literature is thatinternal finance is less costly than externalfinance for firms that have poor access toprimary capital markets.

The empirical studies fall into two cate-gories. The first examines reduced-formcorrelations, while the second looks directly atthe relationship between the cost and expectedreturn to a marginal investment project—theyestimate structural Fuler equations.

Redu~cesd-FtrrroCarreIatiónsFazzari, Hubbard and Petersen (1988)

—10

Difference Between Loan and SecurityResponse to Federal Funds Rate Shockfpersentage change at annual rate with two standard.doviaden bends)

25

20

IS

10

S

0

pioneered the technique of dividing firm-leveldata into groups using measures thought to

correspond to the project monitoring costscreated by information asymmetries, andthen seeing if the correlation between invest-ment and cash-flow measures varies acrossthe groups. The finding in a wide range of

studies is that investment is more sensitiveto cash-flow variables for firms who haveready access to outside sources of funds.3t

The main issue in interpreting theseresults is whether the characteristics of thefirm used to split the sample are exogenousto financing decisions. Measures of firmsize, dividend policies, bond ratings and thehke may be related to thequahty ofinvestmentprojects a firm has available, and so lenderdiscrimination may not be a consequence ofasymmetric information.

There are several examples in whichresearchers identify potentiafly constrainedfinns based on institutional characteristics, andso the endogeneity problems are mitigated.I will mention two, Hoshi, Kashyap andScharfstein (1991) find that investment byJapanese firms that were members of akeiretsu, or industrial group, was not influ-enced by liquidity effects. Using data onindividual hospitals, Calem and Rizzo (1994)find that investment depends more heavily oncash-flow variables for small, single-unit hos-pitals than for large, network-affiliated ones.

In the most convincing study of thistwe, Calomiris and Hubbard (1993) study

25 lernanke, Gertlen and Gilchrist(1994) survey the large number ofstudies that use this appmach.

FEDERAL RESERVE BARK OF ST. LOUIS

0 2 4 6 8 10 12 14 16 18 20 22 24Horizon in months

93

HF~IF~MAY/JUNE 1Q95

‘°Oliaer and tadebesch (1994) andBernanke, Gertler and Gilchnist11994) obtain similar results esingthe Oft data as well.

the undistributed corporate profits tax in1936 and 1937 to estimate the differences infinancing costs directly from firms’ responsesto the institution of a graduated surtaxintended to force an increase in the dividendpayout rate. Their results, holding investmentopportunities fixed, are that investmentspending is affected by the level of internalfunds only for those firms with low levels ofdividend payments and high marginal taxrates. Furthermore, these tended to besmaller and faster growing firms.

brructurat n<rts<ric~rtonThe neoclassical theory of investment

allows one to derive the complex equilibriumrelationship among the capital stock, rates of

return, future marginal value products andproject costs that form the first-order condi-tions for a firm’s problem. With the appro-priate data, it is then possible to see whetherthese Euler equations hold. Hubbard andKashyap (1992) is an interesting use of thistechnique. Following the work of Zeldes(1989) on consumption, they examinewhether the ability of agricultural firmsto meet this first-order condition dependson the extent of their collaterizable networth. They find that during periods whenfarmers have high net worth, and so havebetter access to external financing, theirinvestment behavior is more likely to look asif it is unconstrained.

These investment studies have been very

successful in establishing the existence ofcapital market imperfections as well as theirlikely source in information asymmetriesarising from monitoring problems. Whilethe work has little to say about monetarypolicy directly it does provide an excellentcharacterization of the distributional effectsof changes in the health of firms’ balancesheets regardless of the source.

thne-ziseryes LCo.taeroc.te

The strategy in the second set of studies

is to use the cross-sectional dimension toidentify the transmission mechanism, Thegoal is to determine whether the reduction in

loans during monetary contractions is a con-

sequence of shifts in loan demand or loansupply My conclusion is that these studiesfail to establish the desired result in a con-vincing way Instead, they provide furtherevidence of capital market imperfections.

Three major studies use data on manu-facturing firms. In the first, Gertler andHubbard (1988) find that the impact of cashflow on investment is higher during recessionsfor firms that retain a high percentage oftheir earnings. The second, by Kashyap,Lamont and Stein (1992), shows that duringthe 1981-82 recession, the inventories offirms without ready access to externalfinance fell by more when their initial levelof internal cash was lower. On the otherhand, the inventory investment behavior offirms with ready access to primary capitalmarkets showed no evidence of liquidity

constraints. In the third, Gertler andGilchrist (1994) use the Quarterly FinancialReport for Mantefacturing Corporations (QFR)to divide firms into asset-size categories andfind that small firms account for a dispropor-tionate share of the decline in manufacturingfollowing a monetary shock,’2

Both Kashyap and Stein (1994b) andPeek and Rosengren (forthcoming) focus onthe behavior of lenders rather than borrow-

ers. By examining the cyclical behavior ofbanks, Kashyap and Stein hope to find evi-dence for the importance of loan supplyshifts, The strongest result in their paper isthat, following a monetary contraction, thetotal quantity of loans held by small banksfalls while that of large banks does not. Bycontrast, Peek and Rosengren study NewEngland banks during the 1990-91 recessionand find that poorly capitalized banks shrinkby more than equivalent institutions withhigher net worth. My interpretation is thatboth of these show that the capital marketimperfections commonly found to apply to

manufacturing firms apply to banks as well.There are two difficulties inherent in any

attempt to establish that the important trans-

mission rhechanism for monetary policyshocks is through bank loan supply shifts.First, as described at length in the second

section, there is the problem of empiricallyidentifying monetary policy Beyond this,there is the subtlety of distinguishing loan

FEDERAL RESERVE BANK OF ST. LOUIS

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supply shifts from the balance sheet effects.Is the observed reduction in loans a conse-

quence of their complementarity with outsidemoney caused by the structure of the bankingsystem, or is it the result of changes in theshape of the marginal efficiency of investment

schedule brought on by the balance sheeteffects? Kashyap, Lamont and Stein (1992)suggest one possible way of distinguishing

these possibilities. If one can find a reces-sionary period that was not preceded by amonetary contraction, and show that interestrates rose but that bank dependence wasirrelevant to individual firms’ experiences,this would mean that banks are responsible

for the distributional effects induced bymonetary shocks. Unfortunately suchevidence is not readily available.

sSSs5555SS<55< 5<’05<5<55555<45#<vOS

After a survey of the work that attemptsto distinguish theories of the monetary trans-mission mechanism, where do we stand?

My conclusion is that the myriad studieshave succeeded in establishing the empiricalimportance of credit market imperfections.This means that monetary policy shifts havean important distributional aspect thatcannot he addressed within the traditionalmoney view. It is the smaller and fastergrowing firms that bear a disproportionate

share of the burden imposed by a recession.Since these are likely to he firms with highly

profitable investment opportunities, this hasimportant implications for social welfare.Not only are recessions associated with

aggregate output and investment declines,but the declines are inefficient.

Beyond this, there is the issue of distin-guishing the two parts of the lending view.Do we care if we can distinguish changes ininvestment opportunities resulting fromfinancial accelerator effects from bank loan

supply shifts per se? Does the conclusionhave implications for the actual conduct ofmonetary policy? I believe the answer is yes.

If the complementarity of bank loans andoutside money arises largely as a result of thefinancial regulatory environment, then, with

financial innovation and liberalization, theseeffects are likely to become less important

over time. With the introduction of interstatebanking and the development of moresophisticated instruments aimed at tradingpools of loans, it is only the balance sheeteffects that will remain, As a result, it isimportant to know which is the more impor-tant channel of monetary policy transenission.

Bernanke, Ben S. “How Important is the Credit Channel in theTransmission of Monetary Policy? A Comment,” Carnegie-RochesterConference Series on Public Policy 39 (December 1993) pp. 47-52.

___________ - “Credit in the Macroeconomy,” Federol Reserve Book ofNew York Quarterly Review (spring 1993) pp. 50-70.

__________ ond Mark Gertler. “Financial Fragility and EconomicPerformance,” Quarterly Journal of Economics (February 1990), pp.87-114.

___________ and Mark Gerfier “Agency Cost, Net Worth ond BusinessFluctuatians,” The American Economic Review (March 1989),pp. 14-31. -

_________ and Alan S. Blinder. “The Federal Funds Rate and theChannels of Monetary Transmission,” The American Economic Review(September 1992), pp. 901-21.

_________ Mark t3erfler and Simon Gilchrist. “The Financial Acceleratorand the Flight to Quality,” National Bureau af Economic ResearchWorking Paper No. 4789 (July 1994).

Brainard, William C., and James Tobin. “Financial Intermediaries andthe Effectiveness of Monetary Cantrals,” The American EconomicReview (May 1963), pp. 383-400.

Boschen, John F., and leonardO. Mills. “The Effects of CountercyclicalMonetary Policy an Maney and Interest Rates: An Evaluation ofEvidence from FOMC Documents,” working paper (1992), College ofWilliam and Mary.

Calem, Pool, and John A. Rizza. “financing Constraints and Investrenent:New Evidencefrom Hospital Industry Data,” working paper (1994),Yale University, School of Medicine, Department of Epidemiology andPublic Health.

Calamiris, Charles W., Charles P. Himmelberg and Paul Wachtel.“Commercial Paper and Corporate Finance: A MicroecanomicPerspective,” working paper (April 1994), Stern School of Business,New York University.

__________ and R. Glenn Hublmrd. “lax Policy, Internal Finance, andInvestment,” Internal Finance and Investment Evidence from theUndistributed Corporate Praf its Tax of 1936-37, Notional Bureau ofEconomic Resenrth Working Paper No. 4288 (March 1993).

Cecchetti, Stephen C. “Testing Short Run Neutrality: InternationalEvidence,” Review of Economics and Stotisllcs (february 1987)pp. 135-40.

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_________ “Testing Short Run Neutrality,” Journal of Monetary lames, Christopher ‘Some Evidence on the Uniqueness of BunkEconomics (May1986) pp. 409-23. loans,” Journal of Financial Economics (1987), pp. 217-36.

Christiano, Lawrence, and Martin S. Eirhenbaum. “Liquidity Effects and Koshyop, kril K., and Jeremy C. Stein. “Monetary Policy and Bankthe Monetary Transmission Mechanism,” The American Economic lending,” in N. Gregory Mankiw, ad., Monetary Policy University ofReview (May 1992) pp. 346-53. Chicago Press for the Notional Bureau of Economic Research, 1994,

pp. 221-62.Doon, Thomas A. User’s Monual, RATS Version 3.10. VAR Econometrics, _________ and _________- “The Impact of Monetory Policy on Bank

1990. Balance Sheets,” working paper (March 1994), University of

Fama, Eugene F. “Banking in the Theory of Finnnce,’ Journalof Chicogo, Graduate School of Business.Monetary Economics (January 1980) pp 39~57 _________- Jeremy C. Stein ond David W. Wilcox. “Monetary Policy

ond Credit Conditions: Evidence from the Composition of ExternalFazzari, Steven M., R. Glenn Hubhord and Bruce C. Petersen. Finance,” The American Economic Review (Morch 1993), pp. 78-98.

“Financing Constroints and Corporate Investment,” Brookings Poperson Economic Activity (1988:1) pp. 141-95, , Owen A. Lomont and Jeremy C. Stein. “Credit Conditions

and the Cyclical Behavior of Inventories: A Case Study of the 1981-Feurst, Timothy. “Liquidity Effect Models and Their Implications for 1982 Recession,” Notional Bureau of Economic Research Working

Monetary Policy,” working paper (April 1993), Bowling Green State Paper No. 42t I (November1992).University, Department of Economics. King, Robert G., and Charles I. Plosser. “Money, Credit and Prices in A

Friedman, Benlamin M. “Discussion of ‘New Evidence on the Monetary Real Business Cycle,” The American Economic Review (June 1984),Transmission Mechanism,” Brookings Papers on Economic Activity pp. 363-80.(1990:1), pp. 204-9. King, Stephen R. “Monetary Transmission: Through Bank Loans or

Bank Liabilities?” Journal of Money, Creditand Bonking (August_________and Kenneth N. Kuttnec “Economic Activity and the Short- 1986), 29g,3O3.

Term Credit Markets: An Analysis of Prices and Quantities,” Brookings Kiyotoki, Nobuhiro, ond John Moore. “Credit Cycles,” working paperPapers on EconomicActivity (1993:2), pp. 193-266. (March 1993), London School of Economics.

Friedmon, Milton, and Anna Schwartz. A Monetary History of the United Lucas, Robert E., Jr. “Liquidity and Interest Rates,” Journal of EconomicStates, 1867-1960. Princeton University Press, 1963. Theory (1990), pp. 237-64.

Gertler, Mark, and Simon Gilchrist. “Monetary Policy, Business Cycles, Miran, Jeffrey, Christina D. Romer and David Weil. “Historicaland the Behavioral Small Manufacturing Firms,” Quarterly Jaurnol of Perspectives on the Monetary Transmission Mechanism,” in N. GregoryEconomics (May 1994) pp. 309-40. Monkiw, ed., Monetary Policy. University ofChicago Press for the

Notional Bureau of Economic Research, 1994, pp. 263-306.________ and ________- “The Role of Credit Market Imperfections Morgan, Donald P. “The Lending View of Monetary Policy and Bankin the Monetary transmission Mechanism: kguments and Evithnce,” Loan Cammitanents,” working paper (December 1992), Federal

Scandinavian Journal of Economics (1993) pp. 34-64. Reseme Bank of Kansas City.

__________ and R. Glenn Hubbard. “Financial Factors in Business Oliner, Stephen, and Glenn 0. Rudebusch. ‘Is there a Bank CreditFluctuations,” National Bureau of Economic Research Working Paper Channel for Monetary Policy?” Board of Governors of the FederalNo. 2758 (November 1988). Reserve System, Finance and Econamics Division Discussion Paper No.

93-8 (february 1993).Hamilton, James 0. Time SeriesAnalysis. Princeton University Press, 1994.Peek, Joe, and Eric Rosengren. “The Capital Crunch: Neither o Borrower

Hoover, Kevin 0., and Stephen J. Perez. “Post Hac Ergo Prupter Hoc Nor a Lender Be,” Journal of Money, Creditand BankingOnce More: An Evaluation of ‘Does Monetary Policy Mailer?’ in the (forthcoming).Spirit of James Tobin,” Joumal ofMonetary Ecanomics (february Post, Mitchell A. “The Evolution of the U.S. Commercial Paper Market1992), pp. 3-24. Since 1980,” Fedeml Reserve Bulletin (December 1992),

Hoshi, Takeo, Anil K. Kashyop and David Scharfttein. “Corporate pp. 879-91.Structure, Liquidity and Investment: Evidence from Japanese Panel Ramey, Valerie. “How Important is the Credit Channel in theData,” Quarterly Journal ofEconomics (February 1991), pp. 33-60, Transmission of Monetary Policy?” Camegie’Rochester Conference

Series on Public Policy (December1993), pp. 1-45.Hubbord, R. Glenn. “Is There a ‘Credit Channel’ for Monetary Policy?”

this Review (May/June), pp. 63-82. Romer, Christina 0., and David H. Romer, “Credit Channels ar CreditActions? An Interpretation of the Postwar Transmission Mechanism,”

_________ and Anil K. Kashyop. “Internal Net Worth and the in Chonging CapitalMarkets: Implications forMonetary Policy.Investment Process: An Application to U.S. Agriculture,” Jaurnal of Federal Reserve Bank of Kansas City, 1993.Politicot Economy (June 1992) pp. 506-34.

___________ and ___________. “New Evidence on the MonetaryIngersoll, Jonathan F. Theory of Financial Decision Making. Rowman Transmission Mechanism,” Brookings Papers on EconomicActivity

and tittlefield, 1987. (1990:1), pp. 149-213,

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_________ and _________ “Daes Monetary Policy Mailer? A New Sfiglitz, Jaseph E., and Andrew Weiss. ‘Credit Rationing in Markets withTest in the Spitit of Friedman and Schwartz,” National Bureau at Imperfect lnfarmntian,” The American Economic Review (June 1981),Economic Research Mocroecanomics Annual. MIT Press, 1989, pp. 393-410.

121-10. Strongin, Steven. “The Identification of Monetary Palicy Disturbances:

Sargent, Tharnns 1. Macroeconomic Theory, Second Edition. Academic Explaining the Liquidity Puzzle,” Federal Reserve Bank of ChicagaPress, 1987. Working Paper Na. 92-27 (November 1992).

Sellan, Gordon H., Jr. “Measuring Manetory Policy,” working paper Zeldes, Stephen P ‘Consumption and liquidity Constraints: An(August1994), Federal Reserve Bank of Kansas City. Empirical Investigation,” Journal of Political Economy (Apdl 1989),

pp. 305-46.Shapiro, Matthew 0. Federal Reserve Policy: Cause nnd Effect, in N.

Gregory Mankiw, ed., Monetary Policy. University of Chicago Press farthe Notional Bureau of Economic Research, 1994, pp. 30T34.

Sims, Christopher “Interpreting the Mncraeconomic Time Series facts:The Effects of Manetory Policy,” European Economic Review (May1992), pp. 975-1000,

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