Is the lending channel of monetary policy dominant in Australia? (Revised)

Abstract

A long-standing macroeconomic issue is how monetary policy affects the real economy. The lending view is that tight money affects aggregate demand by shifting the supply schedule left in the bank loan market. Previous studies have found that loans contract following tight money. It is not clear whether the financial contraction reflects a shift of the supply schedule or the demand schedule in the loan market, however. In an attempt to identify the shifts of the demand and supply schedules in the Australian loan market, this paper employs an original approach, which includes the quantity and the price of new loans. A variety of robustness check confirms that the lending view is not supported. The paper also examines features of Australian bank behaviour which make the lending view less plausible.