monetary transmission channel

Topics: Inflation, Monetary policy, Money Pages: 5 (711 words) Published: September 29, 2013
s have shown that the interest rate channel is a weak channel of the monetary chanism. For example, Bernanke and Gertler (1995) in their paper provide two y the conventional interest rate channel may be weak (refer to your reading list). e that spending, especially on durable goods are fairly insensitive to short-term Monetary transmission channels: Various channels through Δ Money Supply affect the aggregate economy. Second, according to the interest rate channel, monetary policy should have its Transmission mechanism of monetary policy: Links btw Δ Money supply + Δ output (Y), employment and inflation (π) ce on short-term interest rates like the overnight rate in Canada and its weakest The impact of Monetary Policy affects Aggregate Money Demand and affect Output, Employment and Prices. rm rates. However, it is puzzling to see that monetary policy has large effects long-lived assets which respond to real long-term rates and not necessarily to 1) Traditional interest rate channel (Keynesian model):

 
 
 
 
 
 
 
 
i
 ↑ ,
 M
 ↓ ,
 I&C
 ↓ , Y
 ↓ ,
 π
 ↓
 

hange rate channel

• Tight (Contractionary) Monetary Policy ⇒ nominal interest rate rise ⇒ Price are sticky, Real interest rate rise eal interest rates increase as a result of a contractionary monetary policy, this leads Real interest rate rise ⇒ cost of borrowing rise ⇒ Less Investment apital (deposits in Canada becomes more attractive), leading to an appreciation Real interest rate rise ⇒ Positive Income effect: Consumers who depend on interest rate⇒ Income gain, can consume more. In turn, this appreciation of the currency makes domestic goods consumption today is expensive relative to future price. Negative Substitution effect: Price of more expensive

reby causing exports to fall. On the other hand, imports become cheaper, thereby Substitution effect > Income effect ⇒ Less Consumption
ase in domestic imports. fall, inflation fall
Aggregate Demand Overall, the tight monetary policy leads to a fall in regate demand and hence inflation. The schematic for the monetary transmission operates*Interest rate channel believeschannel is given below (where E is the number on short-term, and weak influence on long through the exchange rate that Monetary Policy should have strong influence ars a unit of rates. However, monetary policy has large effects on real long-term rates , but not short-term, so interest rate channel is term foreign currency can buy).

a week channel of monetary transmission mechanism.

i ↑⇒ M ↓⇒ E ↓⇒ Y ↓⇒ π ↓.
2) Exchange Rate Channel:

ice channel

 i↑ , M↓ , E↓ , NX↓ , Y
 ↓ , π↓
 

 
channel Tight (Contractionary) Monetary through Domestic
 interest
 monetary policyinflow of capital (more attractive for
is also another important way Policy ⇒ which changes in rate  rise
 ⇒ more
my. Oneforeigners) ⇒ appreciation oftraditional Keynesian model getthat it focusses of the weaknesses of the currency, less Canadian dollar is from foreign currency t prices: interest rates and the exchange rate. Monetary policy in practice however prices and real wealth. are now more expensive for foreigners, ⇒ Less exports Less Net Export (less Export- More Import)

Domestic goods
s are often emphasized under the asset price channel: Tobin’s q theory of investment Imports are cheaper for domestic ⇒ More imports
ts on consumption.
Aggregate Demand fall, inflation fall

q

3) Asset price channel: Monetary policies don’t just affect interest rate and exchange rate, but also all asset prices+ wealth.

veloped a theoryTobin’s q which monetary policy affects the economy through its a. through
uation of equities. Tobin defined q as:
q=

market value of f irms
replacement cost of capital

M
 ↓,
 Price
 of
 equity↓,
 q
 ↓ ,
 I
 ↓ ,
 Y
 ↓ , π
 ↓
(1)

The value of the is low high to replacement replacement cost n the valuation of firm firm...
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