Presentation on theme: "The Channels of Monetary Transmission: Lessons for Monetary Policy"— Presentation transcript:
1 The Channels of Monetary Transmission: Lessons for Monetary Policy Frederic S. Mishkin
2 Transmission mechanisms can be classified as: Asset Price Channelsa) Interest rate channelb) Exchange rate channelc) Equity prices channelCredit Channelsa) Bank lending channelb) Balance sheet channel
3 Interest Rate Channels Follow the traditional ISLM modelWhere M= money supplyir= real interest ratePe= expected price levelpe= expected inflationI= investmentY= real outputM ↑, ir ↓, I ↑, Y ↑M ↑, Pe↑, pe↑, ir ↓, I ↑, Y ↑
4 Exchange Rate Channel M ↑, ir ↓, E ↓, NX ↑, Y↑ Derived from macroeconomic models built under a Keynesian frameworkM ↑, ir ↓, E ↓, NX ↑, Y↑Where M = money supplyir= real interest rateE = nominal exchange rateNX = net exportsY = real output
5 Equity Price Channels M ↑, Pe ↑, q ↑, I ↑, Y ↑ a) Tobin’s q Theory: monetary policy affects the real sector through its effect on the valuation of equities.M ↑, Pe ↑, q ↑, I ↑, Y ↑Where M=money supplyPe= equity pricesq = market value of firms/replacement cost of capitalI = investmentY = real output
6 b) Wealth effects on consumption: assumes that consumption is a function of lifetime resources, which include stocks.M ↑, Pe ↑, W ↑, C ↑, Y ↑Where M= money supplyPe= stock pricesW = wealthC = consumptionY = real output
7 Notice that the concept of equity and wealth can be applied to housing and land prices. An increase in house prices leads to an increase in Tobin’s q for housing.An increase in house prices leads to an increase in wealth.
8 Credit Channels Bank Lending Channel M ↑, bank deposits ↑, bank loans ↑, I ↑, Y ↑Notice that the effect of monetary policy of firms isasymmetric. The greater the dependence on bank loans,the greater the effect of monetary policy on investment.
9 Balance-Sheet Channels a) Via the net worth of firmsM ↑, Pe ↑, adverse selection ↓, moral hazard ↓,net worth ↑, lending ↑,I ↑, Y ↑b) Via nominal interest rates and cash flowM ↑, i ↓, cash flow ↑, adverse selection ↓,moral hazard ↓, lending ↑, I ↑, Y ↑
10 c) Via the general price level M ↑, unanticipated P ↑, adverse selection ↓ ,moral hazard ↓ lending ↑, I ↑, Y ↑d) Household Balance-Sheet Effect:M ↑, Pe ↑, value of financial assets ↑, likelihood of financial distress ↓, consumer durable and housing expenditure ↑, Y ↑
11 Lesson for Monetary Policy 1. Dangerous to associate easing or tightening with fall or rise in nominal interest rates.2. Other asset prices besides short-term debt have information about stance of monetary policy.3. Monetary policy effective in reviving economy even if short-term interest rates near zero.4. Avoiding unanticipated fluctuations in price level important: rationale for price stability objective.