Credit Standards and Tight Money

Abstract

OF THE VARIOUS TENETS1 of the availability doctrine, the one which seems to plague economists most is the thesis that commercial banks will tend to systematically raise tlleir standards of credit worthiness during tight money periods, and to lower them during periods of easy money. While financial practitioners (including the monetary authorities) seem to accept this aspect of tight money as a matter of course, economists llave traditionally been more skeptical. Why, they ask, should a banker pass up the chance to take lligher profits in the form of higher interest rates, and clloose instead to eliminate potential borrowers by imposing a more stringent set of credit criteria?2 A good question. Implicit in it is a concept of the bank as an unconstrained profit maximizer; the bank will not invoke other criteria in loan agreements if its sole concern is with profits. The general nature of the answer must therefore lie in placing behavioral restraints on the bank's activities. Hodgman, for example, finds such a constraint in the prime rate convention, which places a lower bound on the loan rate charged even very good customers.3 The bank is

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