Transmission Mechanisms of Monetary Policy 2013 Pearson Education, Inc. All rights reserved.26-2 Transmission Mechanisms ofMonetary Policy Exaines!hetheronevaria"lea##ects another "$ using data to "uild a odel that ex%lainsthechannelsthrough!hichthe varia"le a##ects the other &ransission echanis' &he change in the one$ su%%l$ a##ects interest rates' Interest rates a##ect investent s%ending' Investents%endingisaco%onento# aggregate s%ending (out%ut) 2013 Pearson Education, Inc. All rights reserved.26-3 Traditional Interest-Rate Channels Ani%ortant#eatureo#theinterest-rate transission echanis is its e%hasis on the real (ratherthanthenoinal)interestrateastherate that a##ects consuer and "usiness decisions Inaddition,itiso#tenthereallong-terminterest rate(nottherealshort-terinterestrate)thatis vie!ed as having the a*or i%act on s%ending 2013 Pearson Education, Inc. All rights reserved.26-+ Other Asset Price Channels Inadditionto"ond%rices,t!ootherasset%ricesreceivesu"stantialattentionaschannels#or onetar$ %olic$ e##ects,-#oreign exchange rates-the%riceso#e-uities (stoc.s) 2013 Pearson Education, Inc. All rights reserved.26-/ Figure 1The Link et!een Monetary Policy and Aggregate "emand# Monetary Transmission Mechanisms 2013 Pearson Education, Inc. All rights reserved.26-6 To$in%s q Theory &heor$ that ex%lains ho! onetar$ %olic$ can a##ect the econo$ through its e##ects on the valuation o# e-uities (stoc.) 0e#inesqasthear.etvalueo##irsdivided"$ the re%laceent cost o# ca%ital I# q is high, the ar.et %rice o# #irs is high relative tothere%laceentcosto#ca%ital,andne!%lant ande-ui%entca%italischea%relativetothe ar.et value o# #irs 1henqislo!,#irs!illnot%urchasene! investentgoods"ecausethear.etvalueo# #irs is lo! relative to the cost o# ca%ital 2013 Pearson Education, Inc. All rights reserved.26-2 &ealth 'ffects 3ranco 4odigliani loo.ed at ho! consuers5 "alance sheets ight a##ect their s%ending decisions Consum(tioniss%ending"$consuerson nondura"le goods and services Ani%ortantco%onento#consuers5li#etie resourcesistheir#inancial!ealth,aa*or co%onent o# !hich is coon stoc.s 1hen stoc. %rices rise, the value o# #inancial !ealth increases, there"$ increasing the li#etie resources o# consuers, and consu%tion should rise 2013 Pearson Education, Inc. All rights reserved.26-6 Credit )ie! &hisex%lanation,re#erredtoasthecredit view,%ro%osesthatt!ot$%eso#onetar$ transissionchannelsariseasaresulto# #inancial#rictionsincreditar.ets,those that o%erate through e##ects on "an. lending andthosethato%eratethroughe##ectson #irs5 and households5 "alance sheets 2013 Pearson Education, Inc. All rights reserved.26-7 Credit )ie! *cont%d+ BankLendingChannel:"asedontheanal$sisthat deonstratesthat"an.s%la$as%ecialroleinthe #inancials$ste"ecausethe$arees%eciall$!ell suited to solve as$etric in#oration %ro"les in credit ar.ets BalanceSheetChannel:8i.ethe"an.lending channel, the "alance sheet channel arises #ro the %resence o# #inancial #rictions in credit ar.ets 2013 Pearson Education, Inc. All rights reserved.26-10 Credit )ie! *cont%d+ 9ash 3lo! 9hannel, another "alance sheet channel o%erates "$ a##ecting cash #lo!, the di##erence "et!een cash recei%ts and cash ex%enditures :nantici%ated Price 8evel 9hannel, another "alance sheet channel o%erates through onetar$ %olic$ e##ects on the general %rice level 2013 Pearson Education, Inc. All rights reserved.26-11 ,ousehold Li-uidity 'ffects Another !a$ o# loo.ing at ho! the "alance sheet channel a$ o%erate through consuers is to consider li-uidit$ e##ects on consuer dura"le and housing ex%enditures I#, as a result o# a "ad incoe shoc., consuers needed to sell their consuer dura"les or housing to raise one$, the$ !ould ex%ect a "ig loss "ecause the$ could not get the #ull value o# these assets in a distress sale In contrast, i# consuers held #inancial assets (such as one$ in the "an., stoc.s, or "onds), the$ could easil$ sell the -uic.l$ #or their #ull ar.et value and raise the cash 2013 Pearson Education, Inc. All rights reserved.26-12 &hy Are Credit Channels Likely to e Im(ortant. &herearethreereasonsto"elievethat creditchannelsarei%ortantonetar$ transission echaniss' 1.alarge"od$o#evidenceonthe"ehavioro# individual#irssu%%ortsthevie!that#inancial #rictionso#thet$%ecrucialtotheo%erationo# creditchannelsdoa##ect#irs5e%lo$entand s%ending decisions 2013 Pearson Education, Inc. All rights reserved.26-13 &hy Are Credit Channels Likely to e Im(ortant. *cont%d+'2.thereisevidencethatsall#irs (!hichareoreli.el$to"ecredit-constrained)arehurtore"$tight onetar$%olic$thanlarge#irs,!hich are unli.el$ to "e credit-constrained 2013 Pearson Education, Inc. All rights reserved.26-1+ &hy Are Credit Channels Likely to e Im(ortant. *cont%d+-3.theas$etricin#orationvie!o# credit ar.et i%er#ections at the core o# the credit channel anal$sis is a theoretical constructthathas%roveduse#ulin ex%lainingan$otheri%ortant %henoena,suchas!h$an$o#our #inancialinstitutionsexist,!h$our #inancials$stehasthestructurethatit has,and!h$#inancialcrisesareso daaging to the econo$ 2013 Pearson Education, Inc. All rights reserved.26-1/ Lessons for Monetary Policy 3our "asic lessons,' 1.It is dangerous al!a$s to associate the easing or the tightening o# onetar$ %olic$ !ith a #all or a rise in short-ter noinal interest rates' 2. ;ther asset %rices "esides those on short-ter de"t instruents contain i%ortant in#oration a"out the stance o# onetar$ %olic$ "ecause the$ are i%ortant eleents in various onetar$ %olic$ transission echaniss 2013 Pearson Education, Inc. All rights reserved.26-16 Lessons for Monetary Policy *cont%d+' 3. 4onetar$ %olic$ can "e e##ective in reviving a !ea. econo$ even i# short-ter interest rates are alread$ near