1. Chapter 27 Information Problems and Channels for Monetary Policy

2. Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 27-2 Macroeconomic Costs of Information Problems Information problems can create obstacles for borrowers who need external financing. Asymmetric information makes it difficult and costly to match savers and borrowers. Information problems typically make external financing more expensive. Investment spending is tied to the amount of a firm’s internal funds.

3. Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 27-3 Figure 27.1 Effects of a Restriction on Bank Lending

4. Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 27-4 Figure 27.2 Effects of a Decline in Borrowers’ Net Worth

5. Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 27-5 Financial Panics During the late 1800s and early 1900s, the United States had several financial panics. A financial panic causes the AD curve to shift to the left, resulting in less output. Research has shown that a financial panic increased the severity of the Depression.

6. Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 27-6 Credit Controls and Credit Crunches In recent years bank lending has declined because of the imposition of credit controls. A credit crunch is a decline in either the ability or the willingness of banks to lend. In the early 1980s banks had to curtail their lending because of disintermediation. Concerns about balance sheets caused a credit crunch in the 1990-1991 recession.

7. Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 27-7 The Money Channel The money channel refers to the money supply effects on interest-sensitive components of aggregate demand. Loans by financial institutions play no special role in the money channel. The money channel ignores financial intermediaries’ role in information costs.

8. Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 27-8 Figure 27.3 Monetary Expansion Effects in the Money Channel

9. Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 27-9 The Bank Lending Channel The bank lending channel emphasizes the behavior of bank-dependent borrowers. A monetary expansion increases banks’ ability to lend. Increases in loans to bank-dependent borrowers increases their spending.

10. Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 27-10 Figure 27.4 Monetary Expansion Effects in the Bank Lending Channel

11. Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 27-11 The Balance Sheet Channel The balance sheet channel refers to the impact of money supply changes on borrowers’ net worth. A monetary contraction by raising interest rates will lower a firm’s net worth and output. Holdings of liquid assets also reduce the likelihood of financial distress.

12. Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 27-12 Figure 27.5 Monetary Expansion Effects in the Balance Sheet Channel

13. Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 27-13 Empirical Evidence The evidence shows that financial intermediaries play a role in determining output. Credit crunches have been felt more by borrowers with high nonbank finance costs. There is a link between the size of the private intermediary sector and economic growth and the rate of capital accumulation.