A New Analysis of Credit Rationing
- New Directions in Modern Economics series
Chapter 2: A Critical Review of the Literature on Credit Rationing
2. A critical review of the literature on credit rationing It has been noted for a long time that the allocation of credit is not guided by the price mechanism alone. In other words, banks not only use price but also use a non-price mechanism to ration credit. This form of behaviour by banks was noted by Keynes (1930, p. 365), as he wrote, There is, that is to say, in Great Britain an habitual system of rationing in the attitude of banks to borrowers – the amount lent to any individual being governed not solely by the security and the rate of interest offered, but also by reference to the borrower’s purposes and his standing with the bank as a valuable or influential client.1 The question is, why is this so? The literature on the theory of credit rationing is vast and the theoretical explanation does not follow from the issue that arises from Keynes’ observation, but rather emerges from a debate that occurred during the 1950s in the USA in relation to how monetary policy works. This debate is known as the availability doctrine. The availability doctrine puts forward a view that even if it is found that investors (i.e. borrowers) are insensitive to changes in the interest rate, monetary policy still works owing to the fact that suppliers of credit are sensitive to changes in the interest rate. This is for the two following reasons. Firstly, they argue that the imperfections in the money market arising from the...
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