By Simon Hall of the Bank’s International Finance Division.
Economic models often assume that the impact on the wider economy of changes in financial conditions can be summarised by a relatively limited range of financial variables, such as risk-free interest rates and long-term government bond rates. But changes in financial conditions can at times have important effects, which these variables do not necessarily indicate. This article reviews so-called ‘credit channel’ models, which consider how changes in the financial positions of lenders and borrowers can affect spending in the economy. These models provide a useful framework for analysing some potentially important interactions between the monetary stability and financial stability objectives of central banks. Subsequent articles in this Bulletin use a specific ‘credit channel’ model to illustrate the potential for these interactions in the UK corporate and household sectors.