The role of uncertainty in the transmission of monetary policy effects on bank lending - Essay Example

It is also shown that the weak, small & intermediate-sized banks tend to lend more than their stronger counterparts, during the time of higher uncertainty (Gatev and Strahan, 2003, pp.867-892). Apart from what is mentioned under bank lending channel, according to Bernanke and Gertler, it also examines the following: a key assumption is that bank is not able to easily replace lost deposits with the other source of funds, such as new equity issue or certificate of deposits (CDs). For several reasons, this assumption was correct for the United States before 1980.

First reason is that, Federal Reserve imposed a “Regulation Q”, which placed a ceiling on the interest rates that bank could pay. Bank does not have any means of competing for funds and therefore suffered sharp reduction in deposits, when the interest rates of open market went above the ceiling. Second, reserve requirement were more difficult at that time than it is today and thirdly, markets for bank liabilities were less developed and less liquid than they are now (Bernanke and Gertler, 1995, pp.40-41). The statement in page number 5 that the reduction in observed lending is not due to a reduction in loan demand, but due to the reduction in loan supply is false.

Rather, it reflects that the reduction in the quantity of loan is due to the decrease in loan demand and the reduction in loan supply (Kashyap and et al, 1993, p.79). One more fact is not mentioned: it takes into account the IS-LM model which states that there are only two financial assets, i.e. money and bonds and when the conditions where all distinctions between securities and bank loan can be ignored are not satisfied, then there are three assets, i.e. money, bank loans and securities. This model also states that monetary policy always operates through liability side of banks’ balance sheet, but the