Explaining Bank Credit Crunches and Procyclicality
Last Updated: 06/13/02
This article shows that the simple model of how monetary policy increases the assets held by the banking system by injecting new reserves and lowering interest rates may be incomplete. In practice, banks are subject to two constraints—capital and reserve requirements. Where capital requirements are binding, injection of reserves may not achieve the intended increase in bank earning assets and may even lead to a decrease. This helps to explain the possibility of a credit crunch.