We show by means of a bank relationship model that after monetary policy tightening, public firms are more likely to decrease their demand for bank loans than private firms, which are typically more dependent on bank credit and benefit more from relationship lending. In order to test this hypothesis, we set up an empirical model relating the use of bank and other debt by private and public firms to an indicator of monetary policy (the short-term interest rate) and a set of firm-level control variables. Our estimation results, based on a sample of around 22,000 firms in the euro area plus the UK during most of the 1990s, yield evidence in favour of relationship lending, particularly for private and small firms.
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