What is the bank lending channel of monetary policy? Should we expect quantitative easing to give rise to a bank lending channel? Introduction
The global financial crisis that followed the infamous collapse of Lehman Brothers in 2008 shook the very roots of the modern financial world. As a result, central banks across the globe were forced to re-evaluate and introduce new strategies in order to neutralise the damaging effects this crisis could potentially have had, and this process continues to this day. In the UK, much academic focus has been devoted to critically appraising the Bank of England’s monetary policy; following the weakening of various big-name UK banks, the BoE has instigated various rounds of quantitative easing in order to alleviate such financial institutions from the inevitable tightening that came about as a result of the crisis. The focus of this paper will be on the bank lending channel of monetary policy in particular with its fundamental link to quantitative easing the centre of critical analysis in the context of wider monetary policy as a whole. In order to analytically debate this question, one must begin by defining the key terms proposed in the question. Quantitative easing is essentially a means by which a central bank can ‘pump money’ into the economy directly. To clarify this simplification, one has to perceive QE as ‘an asset swap that alters the composition of the private sector’s financial assets, but does not add net financial assets’ (Roche, 2011). The conventional method by which this is carried out occurs through the purchase of assets, predominantly government bonds, (in the UK these are referred to as ‘gilts’), using money that is created out of thin air. The financial institutions that sell those bonds then have ‘new’ money in their accounts and this increases the money supply overall. The monetary policy transmission mechanism is fundamentally the umbrella term for the ways in which interest rate changes affect economic activity and inflation. This area is split into various channels that will be detailed further in this essay. One of those channels however, the bank lending channel, is primarily the focus of this question. The BLC is one part of the ‘credit channel’ that works in tandem with the interest rate channel. The BLC alone operates through changes in loan maturity: the detailed explanation of this mechanism will be discussed later on in this paper. Overall, this essay will argue that QE will inevitably give rise to a bank lending channel, but the BLC is less significant in the wider context of monetary policy. Despite the number of limitations on the BLC, it remains an effective channel of monetary policy; nevertheless it continues to be far from being the most potent approach to monetary policy implementation today. Explanation of the mechanism of Quantitative Easing
This paper will begin with a thorough examination of quantitative easing as one method of monetary policy implementation, and will then progress into analysis for the bank lending channel in particular. Hence one must begin by comprehensively grasping the notion of quantitative easing before moving any further. QE, as touched upon in the introduction earlier, is, simply put, a means by which for a central bank such as the BoE to ‘pump new money’ into an economy. The way this works is rather complex however. Initially, a central bank purchases assets using electronic new money. This is designed to inject money directly into the economy. The central bank purchases assets from private sector businesses, including insurance companies, pension funds, high street banks for example. The central bank could even buy assets from a non-financial firm in some cases. Most of the assets they purchase are government bonds however, commonly referred to as ‘gilts’ in the UK. Bonds are conventionally perceived to be a safer investment, holding lower risk and longer maturity periods. When a bank purchases these assets,...
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