Monetary Policy through Ceilings on Bank Lending

Abstract

Credit ceilings Carlo Cottarelli, Giampaolo Galli, Paolo Marullo Reedtz and Giovanni Pittaluga Credit ceilings have been adopted by many OECD countries in the belief that they allow rapid and precise control of activity, inflation and the balance of payments. This paper addresses three key issues. First, are credit ceilings effective when there exist sizeable non-bank financial intermediaries? The answer is clearly more a matter of degree than kind; evidence from Italy suggests that ceilings were initially very powerful but progressively lost their effectiveness as new financial markets developed during the 1970s and the 1980s. However, they remained important as a tool for influencing capital flows. Second, it is often suggested that credit ceilings are effective because they reduce the money supply in addition to constraining spending. We argue they are more likely to affect the demand rather than the supply of money and this may imply a perverse effect through the financial markets. However such an effect is empirically very small in the case of Italy. Finally the paper investigates the costs of controls. Italian evidence indicates that they significantly reduced competition between banks. Ceilings also constrained borrowers to grow at more uniform rates, thus affecting the allocation of resources.

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