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Tue dole of National Bank of Rwanda from 1995 to 2010

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par Paterne RUKUNDO
National university of Rwanda - A0 2011

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2.19. Bank credit and transmission of monetary policy

For modern industrial countries the usual point for a discussion of monetary transmission channels is the effect of monetary on interest rates. Policy changes are transmitted from interest rates to aggregate demand through various channels, first, increase in interest rates reduce the expenditure of private non financial sector by raising the cost of obtaining funds. Second, expenditure of private non financial sector is curbed by negative quantities and land.

Third, interest rates affect the exchange rates and stimulate the economy by changing the international price competitiveness of domestic firms. These combined channels of monetary policy have become known as «money view» of the monetary policy. (Carlos Serrano, 2001: 65).

Several conditions must be presented simultaneously for a bank credit channel of monetary policy to operate (Kashap and Stein, 1994: 278).first, monetary policy must be able to affect the total volume of bank intermediation (securities and loans).

Reserve requirement impose on deposit liabilities are argument for monetary control, but not all bank liabilities are subjected to reserve requirements. Banks can borrow (CDs, equity, bonds loans) to finance intermediation. Even if bank credit is special, the leverage of monetary policy over bank lending may be limited. (Romer, 1990: 51).

According to (Gorton and Pennacchi, 1993: 333), the increase in research on a credit channel for monetary policy can be attributed to four main motives: 1) Desire for new policy instruments in addition to the traditional instrument money supply or interest rates.

They argued that, a bank credit channel might allow central bank actions to affect the real spending of borrowers directly and improve the trade-off between inflation and output objectives, or exchange rate and domestic economic objectives. This concept of credit controls is reminiscent of policies used in many countries. 2) Reduced the share of bank credit in the total amount of funds available to the private sector.

Thonton (1994: 71) and Ceccetti (1995: 30), contend that, if the economic effect of monetary policy depends on the influence that the central bank has on the lending behavior of commercial banks, monetary policy may be in danger of losing its effectiveness.

Furthermore, some authors have argued that deregulation, innovation and global integration of financial market tend to reduce the influence of central bank on market interest rates. While bank credit becomes a reduced factor in funding the private sector, central banks may increasingly have to rely on bank credit channel to affect the economy. 3) To examine the credit channel is to develop a more reliable information variable for monetary policy. The experience in many countries is that the short-run relationship between money aggregates and the economy tends to breakdown time to time. If the credit channel is important, bank credit aggregates may be more reliable indicators of monetary policy effects than money aggregates (Friedman, 1983: 353), changes in the way banks create deposit money may provide useful information on the relationship between money and economy. 4) Use of credit channel is strengthened the case for the proposition that monetary policy affects the real economy. Despite a large body of statistical evidence in favor of short run real effects of monetary policy, the transmission mechanisms remain unclear.

It has remained a somewhat troublesome proposition that relatively small changes on real interest rates cause such pronounced effects on investment, consumer expenditure (Bernanke and Gertler, 1995).

Bernanke and Blinder (1988: 78), Greenwald and Stiglitz (1990: 149) show how interaction with bank credit increases the real effect of monetary policy, while at the same time mitigating the effect on market interest rates.

Bernanke and Blinder (1988: 79) argue that, uses of credit channel dependent on the relationship between money effects and bank credit; effects on economic activity.

Money and bank credit are two sides of the same balance sheet and bank loans are the main source of the expansion of the deposit money in the modern fractional-reserve banking systems. The money view of the transmission of monetary policy contends that, as a first approximation, the volume and the composition of bank credit is important.

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