Abstract
This paper modifies the well-known Mundell-Fleming model by adding equilibrium credit rationing as well as imperfect asset substitutability between bonds and loans. When the representative bank’s backward-bending loan supply curve peaks at its profit-maximizing loan rate, credit rationing can be an equilibrium phenomenon, which makes credit-dependent capital investment solely dependent upon the availability of customer market credit. With credit rationing, an expansion in money and credit shifts the IS curve as well as the LM curve even in a small open economy under a regime of fixed exchange rates, and the magnitude of offset coefficient between domestic and foreign asset components of high-powered money is less than one. In contrast, if there is no credit rationing, imperfect asset substitutability between bonds and loans per se cannot generate the real effect of money in the same model.
JEL classification: E51 F41
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Wu, Y. (2006). Equilibrium credit rationing and monetary nonneutrality in a small open economy. In: Lee, CF., Lee, A.C. (eds) Encyclopedia of Finance. Springer, Boston, MA. https://doi.org/10.1007/978-0-387-26336-6_72
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DOI: https://doi.org/10.1007/978-0-387-26336-6_72
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