The credit channel of monetary policy transmission: evidence from stock returns

CHRISTOPHRE GEORGES [*] This paper offers a novel test of the credit view of the monetary policy transmission mechanism using stock market returns. We identify Fed policy shocks using newspaper accounts and track daily stock prices immediately following the shocks. If the credit channel is important, then firms that are dependent on bank credit and internal funds should receive a relatively greater benefit (loss) from a Fed easing (tightening) than firms with access to nonbank credit at favorable terms. We identify ten policy shocks during the expansion of 1993-94 and the "credit crunch" period of the 1990-91 recession and find little evidence supportive of an operative credit channel. (JEL E5) I. INTRODUCTION Recently there has been renewed interest in the mechanism by which monetary policy innovations are transmitted into changes in aggregate output. According to the traditional "money view monetary policy influences market interest rates, inducing changes in interest-sensitive spending and consequently changes in output. By assumption, there is no distinction between financial assets, and thus bank loans and internal funds are of no special interest. In contrast the "credit view" (e.g., Bernanke and Blinder [1988]) assumes that bank loans are special. Due to information asymmetries some businesses are dependent on banks for loanable funds. A withdrawal of reserves by the Fed causes the supply of bank loans to fall, and bank-dependent businesses consequently reduce their spending. A broader version of this view (e.g., Gertler and Gilchrist [1993]; Bernanke and Gertler [1995]) claims that credit market imperfections contribute to the propagation of monetary policy shocks without working exclusively through the su pply of bank loans. Tight monetary policy may, for example, cause a deterioration of borrowers' net worth, thereby increasing external finance premia. In either case, this transmission mechanism operates through firms that are credit constrained in the sense that nonbank credit is an imperfect substitute for internal funds and bank loans. Empirical evidence on the transmission mechanism has been mixed (see Bernanke and Blinder [1992]; Ramey [1993]; Kashyap et al. [1993]; Gertler and Gilchrist [1993, 1994]; Christiano et al. [1996]; Oliner and Rudebusch [1995, 1996]; Kashyap and Stein [2000]). Two fundamental problems make direct tests of the credit view difficult: the difficulty of identifying exogenous monetary policy shocks, and the difficulty of identifying the relationship between these shocks and subsequent real activity. This article offers a novel empirical test of the credit view using stock market returns. If the credit channel is important, then firms that are credit constrained should receive a relatively greater benefit (loss) from a Fed easing (tightening) than firms with access to nonbank credit at favorable terms. This relative benefit (loss) should be reflected in the behavior of stock prices immediately following news of the Fed policy change. We therefore identify changes in market expectations of Fed policy, calculate abnormal returns (the deviations of the actual returns from the returns predicted by an asset pricing model) for individual securities immediately following these innovations, and test for systematic relationships between these abnormal returns and indicators of credit constraints at the firm level. This approach is more indirect than others in the literature but has the advantage of mitigating the two identification problems noted above. First, the policy shocks that we use are changes in (stock) market expectations of Fed policy. We can identify these closely using daily accounts in the business press. [1] Second, because the stock market reacts quickly to changes in expectations of future profitability, we observe near-contemporaneous responses of stock prices to policy shocks regardless of when in the future profits are expected to be altered. …