Credit Channel or Credit Actions?: An Interpretation of the Postwar Transmission Mechanism," Federal Reserve Bank of Kansas City

Monetary policy actions affect credit flows in two ways. First, tightening of policy leads to increases in the overall level of interest rates. When prevailing interest rates rise, borrowers may choose to borrow less, and lenders may choose to ration funds to certain types of borrowers. This is the "interest rate side " of the monetary transmis-sion mechanism. Second, monetary policy actions may directly affect the ability of certain types of lenders to obtain funds. Because banks obtain a large portion of their funds from instruments subject to reserve requirements, open market operations, which alter the quan-tity of reserves, may affect the opportunity cost of funds to banks beyond their impact on general interest rates. Monetary policy may therefore particularly affect firms and households that depend on banks for loans. Such effects on the ability of particular classes of lenders to obtain funds are the "credit side " of the transmission mechanism. l Both of these components of the monetary transmission mechanism could be affected by recent changes in American financial institutions and regulations. For example, the development of substitutes for demand deposits and currency, such as money market mutual funds, may lessen the Federal Reserve's ability to control short-term interest rates. Similarly, banks ' increased reliance on nondeposit sources of funds, such as certificates of deposit, and the growth of alternative