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Tracking monetary policy’s effects on access to financing

The federal funds rate (FFR) is a key instrument through which the Federal Reserve conducts monetary policy in the US. When inflation is high, the Federal Reserve typically raises the FFR to mitigate aggregate demand, easing pressure on prices.

One channel through which monetary policy achieves these goals is by increasing borrowing costs for banks and, in turn, the cost of borrowing for firms. As firms find it costlier to borrow, this mitigates their demand for factors of production, easing pressure on prices.

We use FRED data to help us investigate the extent to which monetary policy indeed tightens financial access for firms in the US economy. The graph above plots the time series of the FFR (in red) along with two measures of financial access by US firms: One of these series measures the proportion of domestic banks tightening their lending standards for large and medium-sized firms (in blue). The other measures the same statistic for small firms (in green).

These series are proxies for the financial environment in the US and, more specifically, for the ability of firms to gain access to credit. Increases in these series indicate that a greater amount of banks in the country are tightening their lending standards and restricting access to credit, while a decrease indicates the opposite.

The graph shows four periods of monetary policy tightening (that is, increases in the FFR): from 1993 to 1995, from 1999 to 2001, from 2004 to 2007, and from 2016 to 2019. In all these episodes, the share of banks tightening lending standards increases a few quarters following the monetary policy tightening, which suggests that financial conditions get tighter following monetary policy tightening and that these policy actions take effect with a lag.

In our second FRED graph, we look at the more-recent period since the COVID-19 pandemic. We plot the same series, but starting in January 2020. We first observe a tightening of financial conditions at the outset of the pandemic. We next see a gradual rise in the FFR since March 2022.

The tightening standards of banks (of all sizes) have been steadily rising, even prior to the change in the FFR, perhaps because of policies to reduce the size of the Fed’s balance sheet. Given the long-run link between monetary policy and financial conditions, we may expect credit access to continue to tighten in the coming quarters, enabling the Federal Reserve to reduce inflationary pressures to achieve its mandate of price stability.

How these graphs were created: Search FRED for and select “Net Percentage of Domestic Banks Tightening Standards for Commercial and Industrial Loans to Large and Middle-Market Firms.” From the graph, click on “Edit Graph,” open the “Add Line” tab, and search for and select “Federal Funds Effective Rate” and “Net Percentage of Domestic Banks Tightening Standards for Commercial and Industrial Loans to Small Firms.” Use the “Format” tab to change the y-axis position of the federal funds effective rate to the right-hand side. Set the earliest date in the window to “1990-01-01”.

Suggested by Jason Dunn and Fernando Leibovici.

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