THE ECONOMICS OF MONEY,BANKING, AND FINANCIAL MARKETS 691

CHAPTER 25

Transmission Mechanisms of Monetary Policy

659

thus increasing spending on them and hence aggregate output. The only difference between this view of cash flow effects and that outlined in Equation 8 is that
it is not the willingness of lenders to lend to consumers that causes expenditure
to rise but the willingness of consumers to spend.

Why Are Credit
Channels
Likely to Be
Important?

A PP LI CATI O N

There are three reasons to believe that credit channels are important monetary
transmission mechanisms. First, a large body of evidence on the behaviour of individual firms supports the view that credit market imperfections of the type crucial
to the operation of credit channels do affect firms employment and spending decisions.20 Second, there is evidence that small firms (which are more likely to be
credit-constrained) are hurt more by tight monetary policy than large firms, which
are unlikely to be credit-constrained.21 Third, and maybe most compelling, the
asymmetric information view of credit market imperfections at the core of the
credit channel analysis is a theoretical construct that has proved useful in explaining many other important phenomena, such as why many of our financial institutions exist, why our financial system has the structure that it has, and why financial
crises are so damaging to the economy (all topics discussed in Chapters 8 and 9).
The best support for a theory is its demonstrated usefulness in a wide range of
applications. By this standard, the asymmetric information theory supporting the
existence of credit channels as an important monetary transmission mechanism
has much to recommend it.

National Monetary Policy and

Differential Regional Effects
Our analysis thus far has assumed a uniform national monetary effect. In reality, however, there are quite pronounced regional disparities across a geographically large and diversified country like Canada, meaning that monetary
policy actions may have differential effects on regional economic activity.
In fact, as Gerald Carlino and Robert DeFina (1998) argue, regional differences
in the mix of interest-sensitive industries and in the proportion of large and
small borrowers underscores the complexity of conducting a national monetary policy.22
There is, at present, little evidence on the issue of whether Canadian monetary policy has differential effects on regional economic activity. Empirical evidence on this issue may aid policymakers in their consideration of regional
economic conditions in the formulation of national monetary policy.

20

For a survey of this evidence, see Hubbard, Is There a Credit Channel for Monetary Policy? (note
17).

21

See Mark Gertler and Simon Gilchrist, Monetary Policy, Business Cycles, and the Behavior of Small
Manufacturing Firms, Quarterly Journal of Economics 109 (May 1994): 309 340.

22

Gerald Carlino and Robert DeFina, The Differential Regional Effects of Monetary Policy, The Review
of Economics and Statistics 80 (November 1998): 572 587.