The Channels of Monetary Transmission: Lessons for Monetary Policy

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The Channels of Monetary Transmission Lessons
for Monetary Policy

• Frederic S. Mishkin

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• Transmission mechanisms can be classified as
• Asset Price Channels
• a) Interest rate channel
• b) Exchange rate channel
• c) Equity prices channel
• Credit Channels
• a) Bank lending channel
• b) Balance sheet channel

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Interest Rate Channels

• Follow the traditional ISLM model
• Where M money supply
• ir real interest rate
• Pe expected price level
• pe expected inflation
• I investment
• Y real output

M ?, ir ?, I ?, Y ?
M ?, Pe?, pe?, ir ?, I ?, Y ?
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Exchange Rate Channel

• Derived from macroeconomic models built under a
  Keynesian framework
• M ?, ir ?, E ?, NX ?, Y?
• Where M money supply
• ir real interest rate
• E nominal exchange rate
• NX net exports
• Y real output

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Equity Price Channels

• a) Tobins q Theory monetary policy affects the
  real sector through its effect on the valuation
  of equities.
• M ?, Pe ?, q ?, I ?, Y ?
• Where Mmoney supply
• Pe equity prices
• q market value of firms/replacement cost of
  capital
• I investment
• Y real output

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• 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 supply
• Pe stock prices
• W wealth
• C consumption
• Y real output

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• 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 Tobins q for housing.
• An increase in house prices leads to an increase
  in wealth.

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Credit Channels

• Bank Lending Channel
• M ?, bank deposits ?, bank loans ?, I ?, Y ?
• Notice that the effect of monetary policy of
  firms is
• asymmetric. The greater the dependence on bank
  loans,
• the greater the effect of monetary policy on
  investment.

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• Balance-Sheet Channels
• a) Via the net worth of firms
• M ?, Pe ?, adverse selection ?, moral hazard ?,
• net worth ?, lending ?,I ?, Y ?
• b) Via nominal interest rates and cash flow
• M ?, i ?, cash flow ?, adverse selection ?,
• moral hazard ?, lending ?, I ?, Y ?

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• 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 ?

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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.