Asymmetric Effects of Monetary Policy: Japanese Experience in the 1990's

We consider a competitive bank loan market model where the marginal costs of managing and monitoring loans are assumed to increase as borrowers' net worth decreases. We show that the responsiveness of equilibrium bank loan rates to changes in interbank money market rates become weaker as borrowers' net worth decreases. In other words, monetary policy becomes less effective as borrowers' net worth decreases. We test and confirm this prediction by estimating bank loan rate equations using Japanese data. We find that the effectiveness of expansionary monetary policy in the 1990s has been weakened by the deterioration of borrowers' balance sheets, contributing to the long stagnation of the Japanese economy during the period.