The Prices vs. Quantities Tradeoff in Monetary Policy: An Interpretation of Credit Controls
61 Pages Posted: 11 Sep 2013 Last revised: 12 Sep 2013
Date Written: November 11, 2012
Why do some central banks choose to control directly the quantity of credit rather than to influence indirectly interest rates through market operations? This paper states that the choice of monetary policy instruments is determined not primarily by the nature of the macroeconomic disturbances but by the nature of the interaction between the central bank and the banks. The dilemma prices vs. quantities arises only in a second-best equilibrium because central banks can set a below market-clearing rate.
Following Gilbert and Klemperer (2000), I build a simple positive model that derives under which conditions a central bank has incentives to ration directly the quantity of credit. Asymmetries of information between banks and firms and a monopoly of the central bank on banks refinancing are crucial to this result. A striking conclusion is that rationing at the central bank's discount window (a practice usually associated with financial repression) may increase financial development. The model also offers a new interpretation of expansionary policy when the interest rate does not play any role, such as full allotment, and thus provides an original account of current central banks' policies. Finally, quantitative monetary policy always creates rents: banks may support rationing for political economy reasons. The main purpose of the model is to explain the common use of discount and credit ceilings by central banks in Europe from 1945 to the 1980s and in developing countries today.
As an example, I show how this model sheds light on the choices and consequences of French monetary policy from 1948 to the 1970s.
Keywords: credit controls, discount window, McCallum rule, Bank of France
JEL Classification: N14, E31, E32, E51, E52, E58
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