The credit channel emphasizes the importance of bank lending in the
monetary transmission mechanism. The existence of the credit channel presumesthat capital markets are imperfect, owing to information asymmetries betweenborrowers and lenders. As a consequence, some borrowers are unable to borrow on he open market without paying large premiums on external finance. Banks specialize in information-intensive loans and are able to reduce the premium for bank dependent borrowers. Monetary policy has real consequences because of its effect on banks’ ability to lend. Open market operations lead to a contraction in reserves and a decrease in funds available for lending. As long as banks face
imperfections in issuing certificates of deposit (CDs) to offset the contraction in reserves, bank lending must fall. Bank-dependent borrowers, consequently, are forced to seek funds at a much higher cost on the open market--to the extent they are able to obtain funds at all. As a result, spending by bank-dependent borrowers contracts .