FLIGHT TO QUALITY IN BANKING AND ECONOMIC-ACTIVITY

Recent explanations of the transmission mechanism of monetary policy have emphasized that riskier, lower net worth borrowers are more dependent on bank lending than larger, less risky borrowers. Evidence from the Federal Reserve's Survey on Terms of Bank Lending indicates that the proportion of relatively high quality new loans (%Safe) moves countercyclically and Granger causes GDP and inventory investment. In the aftermath of a tightening of monetary policy, the %Safe variable increases, and in turn, policy tends to relax once %Safe has risen.