Introduction

This paper addresses the question of whether ‘credit’ contains information additional to that available in ‘money’. There has been a long tradition of modelling monetary conditions in the economy by focusing on the demand for money (i.e. banks' liabilities), but monetary policy is implemented via changes in short-term interest rates. Changes to interest rates influence the demand for loans, and it is through the loan market that aggregate spending is affected, at least to some degree. This issue has been addressed in theoretical terms in the ‘credit channel’ literature (see Bernanke and Gertler, 1995), and two variations on the credit channel story have been identified: a balance sheet channel and a bank lending channel. The first links the determinants of lending to observable characteristics of the financial health of the borrowing firms; the second suggests that some influences on lending flows originate within the banking system.

Banks typically have an ongoing relationship with the households and corporations to which they lend, and they use information about a company's financial position obtained through this banking relationship to determine the loan facility they will offer. Factors that are easily monitored, such as cash flow, financial wealth, previous loan payments history and outstanding debt, will affect the ability of a company to obtain loans, as will the value of collateral that a firm is able to offer.