Credit channel of monetary policy in Japan: resolving the supply versus demand puzzle

Abstract

The credit view is that a monetary tightening affects the real economy by shifting the supply schedule of bank credit left. While bank credit typically contracts following a monetary tightening, the financial contraction does not necessarily mean a shift of the supply schedule. Testing the credit view requires the identification of the shifts of the demand and supply schedules of credit. Using an original approach, this study shows that the credit view is supported for Japan. The credit view is, however, composed of two different views, namely the lending view and the balance-sheet view. While the balance-sheet view implies that the cutback of lending has no impact on the real economy, the lending view implies independent impacts of the cutback. Given the acceptance of the credit view, this study further attempts to test the balance-sheet view against the lending view.