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This paper shows that the disproportionate impact of tight monetary policy on banks' ability to lend is largely the consequence of Federal Reserve actions aimed at reducing bank loans directly, rather than an inherent feature of the monetary transmission mechanism. We provide two types of evidence for this conclusion. First, a detailed examination of nine postwar episodes of contractionary monetary policy shows that while short-term interest rates always rose in response to tight policy, banks typically found ways of maintaining lending despite the falls in reserves. Banks' ability to lend was particularly affected by tight policy only when the Federal Reserve undertook actions, such as special reserve requirements, moral suasion, or explicit credit controls, to restrain bank lending directly. Second, simple regressions show that Federal Reserve credit actions have large and significant effects on the composition of external finance between bank loans and commercial paper and on the spread between the prime bank loan rate and the commercial paper rate, and that a bank credit channel of monetary transmission is not needed to explain the movements in these variables in response to tight policy.

Credit Channel or Credit Actions? An Interpretation of the Postwar Transmission Mechanism