Search

This dissertation consists of three essays that study the relationship between distress and credit and the role this relationship has in determining corporate investment and economic activity. The first essay studies the supply of credit during the recent financial crisis. It shows that distress in the banking sector led to bank credit rationing, which a portion of nonfinancial borrowers palliated by migrating to the public market for credit. The overall reduction in credit, however, was followed by a severe drop in corporate investment, which in time led to a fall in the levels of aggregate production. The second essay examines how distress in the banking sector affects credit supply in two separate events: the credit crunch of early 1990s and the financial crisis of late 2000s. While the former is broadly thought of as a relatively mild crisis when compared with the latter, the fall in bank credit that they carried is comparable by certain measures. Government intervention, the paper argues, accounts for the comparatively short duration of and fast recovery from the second crisis. The third essay investigates the role of aggregate economic distress on the maturity of debt, which ultimately affects investment in long-term assets. The paper predicts and shows that increases in the aggregate distress lead lenders to prefer shorter maturities. This effect can be empirically observed in changes in maturity of new debt issues. Moreover, it is strong enough to modify the temporary financial structure of nonfinancial corporations.

Does monetary policy act as a constraint on the quantity of bank credit? Does it affect banks’ risk-taking? Do markets monitor banks’ risk-taking behavior? These questions have important implications on our understanding of the consequences of monetary policy and—in light of recent financial crises—on the design of macro-prudential regulation. I address these question in the context of thrifts--U.S. banks that specialize in mortgage lending--in the years preceding the Sub-prime Crisis. Exploiting loan-level data on banks’ lending, I find that the effects of monetary policy do not conform to traditional theories of the bank lending channel: the quantity of small banks’ lending is not especially sensitive to monetary policy--it is larger banks that are considerably more responsive. I also examine the cross-sectional effects of monetary policy on banks’ risk-taking. Using a novel contemporaneous measure of banks’ risk-taking that I construct from loan approval data, I find that less-capitalized banks’ increase risk-taking more in response to loose policy. This finding suggests that loose policy leads to excessive risk-taking in the presence of agency problems between bank owners and bank liability holders. Finally, I find mixed evidence on the role of market monitoring. Following the economic turmoil of 2001, the market for bank deposits appeared to take note of the differences in the riskiness of banks’ assets; however, the effect declined gradually over the next few years—by the eve of the Sub-prime crisis, it was not measurable.

Over the last thirty years there have been dramatic changes in the monetary policy transmission mechanisms in China. The People’s Bank of China (PBC) began functioning as the central bank in 1984 and since then monetary policy has been used to promote economic growth and control inflation rate. The PBC introduced the “credit growth quota system” in 1986, which was replaced by the window guidance system in January 1998. Meanwhile, financial markets (money market, bond market and stock market) have made significant progresses. During this transition, the intermediate and operating targets also switched to monetary aggregate (M2) and monetary supply respectively, with the adoption of a combination of monetary policy instruments. In this circumstance, China’s monetary policy transmission mechanisms have been one of the most studied topics. First, we test whether an effective interest rate channel exists currently in China using a standard VAR method, because it is the core channel of policy transmission in neoclassical economics and short-term interest rates have been used as the operating target by central banks in all developed economies and most of emerging markets. We test the effects of weighted average 7-day interbank money market interest rate and 7-day repurchase rate on real output, general price level from 1996:Q1 to 2008:Q1 and find that changes in short-term interest rates could not impact on real output and general price level significantly as expected. However, an effective interest rate channel has not come into existence, though significant advancements in market-based interest rate reform have been made during the past two decades. Secondly, we identify bank lending channel in China based on quarterly data covering 1997:Q1 to 2008:Q4. We construct a VECM model using commercial bank one-year lending rate, bank credit aggregate, required reserve ratio, inflation rate and real output. The Johansen cointegration tests identified two cointegration relationships among them. To disentangle the forces between credit demand and credit supply, which drives the changes in credit aggregate, we impose joint restrictions on the two-cointegration relationships simultaneously, and find that the PBC could affect the bank credit supply using required reserve ratio in the long-run equation. The corresponding loading matrix shows us that short-run disequilibria in the long-run relationship could be corrected through bank lending rate. Thirdly, we evaluate the possibility of taking McCallum rule as a monetary policy guideline for the PBC using quarterly data from 1994:Q1 to 2009:Q1. A medium-term or long-term policy rule could provide a stable framework, which reduce uncertainty and increase the credibility and transparency of current and future government policies, monetary policy effectiveness would be improved if the policymaker were to follow a rule. We use a counterfactual simulation method to evaluate the original McCallum rule and an improved McCallum rule. The results show that following the McCallum rule could reduce the root mean square error between nominal GDP target and simulated nominal GDP significantly. Then, we use the historical analysis method to confirm this result. When the actual value of monetary base deviates from the rule-produced values dramatically, China’s economy encounters inflation or deflation problems. Therefore, this study argues for the McCallum rule as a policy guideline for China.

This dissertation examines the role of bank structure on the effectiveness of monetary policy. Using time series data for U.S. banks, I examine the varying effect of monetary policy on bank lending for the period 1976-2003. It is found that as the banking industry gets more concentrated (through mergers and acquisitions), the effect of monetary policy transmission (through open market operations) is being mitigated. That was the result of the deregulation of the banking sector that took place in the first half of the 1990s which led to an unprecedented wave of consolidation in the banking sector. Then I investigate the lending channel evidence at the bank level. That is, how important is the cross-sectional differences in the way that banks with varying characteristics respond to policy shocks. Three bank characteristics are highlighted: bank size, liquidity and capitalization. It is found that large, more liquid, and well capitalized banks are more impervious to changes in monetary policy than other banks. Real estate loans, agriculture, commercial and industrial (C&I), and consumer loans are analyzed. The size of the bank is found to be most crucial for real estate lending, where small banks are much more sensitive to changes in the federal funds rate compared to large banks. The effect is comparatively less pronounced for C&I and consumer lending and largely disappears when it comes to agriculture lending. Finally, the question of monetary policy asymmetry is examined. As expected, monetary policy has more effect on bank lending when it tightens than when it eases interest rates. This is found to be the case for all types of loans except for real estate loans, where a decline of FFR entices more real estate lending than a rise.