CHAPTER 25 Transmission Mechanisms of Monetary Policy 659 thus increasing spending on them and hence aggregate output The only difference between this view of cash flow effects and that outlined in Equation is that it is not the willingness of lenders to lend to consumers that causes expenditure to rise but the willingness of consumers to spend Why Are Credit Channels Likely to Be Important? A PP LI CATI O N There are three reasons to believe that credit channels are important monetary transmission mechanisms First, a large body of evidence on the behaviour of individual firms supports the view that credit market imperfections of the type crucial to the operation of credit channels affect firms employment and spending decisions.20 Second, there is evidence that small firms (which are more likely to be credit-constrained) are hurt more by tight monetary policy than large firms, which are unlikely to be credit-constrained.21 Third, and maybe most compelling, the asymmetric information view of credit market imperfections at the core of the credit channel analysis is a theoretical construct that has proved useful in explaining many other important phenomena, such as why many of our financial institutions exist, why our financial system has the structure that it has, and why financial crises are so damaging to the economy (all topics discussed in Chapters and 9) The best support for a theory is its demonstrated usefulness in a wide range of applications By this standard, the asymmetric information theory supporting the existence of credit channels as an important monetary transmission mechanism has much to recommend it National Monetary Policy and Differential Regional Effects Our analysis thus far has assumed a uniform national monetary effect In reality, however, there are quite pronounced regional disparities across a geographically large and diversified country like Canada, meaning that monetary policy actions may have differential effects on regional economic activity In fact, as Gerald Carlino and Robert DeFina (1998) argue, regional differences in the mix of interest-sensitive industries and in the proportion of large and small borrowers underscores the complexity of conducting a national monetary policy.22 There is, at present, little evidence on the issue of whether Canadian monetary policy has differential effects on regional economic activity Empirical evidence on this issue may aid policymakers in their consideration of regional economic conditions in the formulation of national monetary policy 20 For a survey of this evidence, see Hubbard, Is There a Credit Channel for Monetary Policy? (note 17) 21 See Mark Gertler and Simon Gilchrist, Monetary Policy, Business Cycles, and the Behavior of Small Manufacturing Firms, Quarterly Journal of Economics 109 (May 1994): 309 340 22 Gerald Carlino and Robert DeFina, The Differential Regional Effects of Monetary Policy, The Review of Economics and Statistics 80 (November 1998): 572 587