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1、Chapter 26Transmission Mechanisms of Monetary Policy:The Evidence 2005 Pearson Education Canada Inc.Two Types of Empirical EvidenceStructural Model EvidenceM i I YReduced Form EvidenceM?YStructural Model EvidenceAdvantages:1.Understand causation because more information on link between M and Y2.Know
2、ing how M affects Y helps prediction3.Can predict effects of institutional changes that change link from M to YDisadvantages:1.Structural model may be wrong,negating all advantages 2005 Pearson Education Canada Inc.2Reduced Form EvidenceAdvantages:1.No restrictions on how M affects Y:better able to
3、find link from M to YDisadvantages:1.Reverse causation possible2.Third factor may produce correlation of M and Y3 2005 Pearson Education Canada Inc.Early Keynesian EvidenceEvidence:1.Great Depression:i on T-bonds to low levels monetary policy was“easy”2.No statistical link from i to I3.Surveys:no li
4、nk from i to IObjections to Keynesian evidenceProblems with structural model1.i on T-bonds not representative during Depression:i very high on low-grade bonds:Figure 1 in Ch.62.ir more relevant than i:ir high during Depression:Figure 13.Ms during Depression(Friedman and Schwartz):money“tight”4.Wrong
5、 structural model to look at link of i and I,should look at ir and I:evidence in 1 and 2 suspect 2005 Pearson Education Canada Inc.4Real and Nominal Interest Rates5 2005 Pearson Education Canada Inc.Early Monetarist EvidenceMonetarist evidence is reduced formTiming Evidence(Friedman and Schwartz)1.P
6、eak in Ms growth 16 months before peak in Y on average2.Lag is variableCriticisms:1.Uses principle:Post hoc,ergo propter hoc2.Principle only valid if first event is exogenous:i.e.,if have controlled experiment3.Hypothetical example(Fig 2):Reverse causation from Y to M and yet Ms growth leads Y6 2005
7、 Pearson Education Canada Inc.Hypothetical Example in Which M/M leads Y7 2005 Pearson Education Canada Inc.Statistical EvidenceHorse race:correlation of A vs M with Y;Friedman and Meiselman,M winsCriticisms:1.Reverse causation from Y to M,or third factor drivingM and Y are possible2.Keynesian model
8、too simple,unfair handicap3.A measure poorly constructedPostmortem with different measures of A:no clear-cut victory8 2005 Pearson Education Canada Inc.Historical EvidenceFriedman and Schwartz:Monetary History of the U.S.1.Important as criticism of Keynesian evidence on Great Depression2.Documents t
9、iming evidenceMore convincing than other monetarist evidence:Episodes are almost like“controlled experiments”1.Post hoc,ergo propter hoc applies2.History allows ruling out of reverse causation and third factor:e.g.,193637 rise in reserve requirements and 1937-38 recession9 2005 Pearson Education Can
10、ada Inc.Monetary Transmission MechanismsTraditional Interest-Rate Channels:M ,ir ,I ,Y The interest rate channel of monetary transmission applies equally to C.Also,it places emphasis on ir rather than i.Moreover,it is the long-term ir and not the short-term ir that is viewed as having the major impa
11、ct on C and I spending.With sticky P,an in M leads to a in short term i and also short term ir.According to the expectations hypothesis of the term structure of interest rates,this also long-term ir.The in short-and long-term ir leads to an in C and I spending.Note:The interest rate transmission mec
12、hanism is effective even when i has already been driven to zero by the MA during a deflationary period.With i=0,M,Pe,e,ir,C and I,Y 10 2005 Pearson Education Canada Inc.Monetary Transmission MechanismsOther Asset ChannelsExchange Rate Channel:M ,ir ,E ,NX ,Y When ir the domestic currency depreciates
13、(see Chapter 7),that is E.This makes domestic goods relatively less expensive and NX.Recent work indicates that the exchange rate transmission mechanism plays an important role in how monetary policy affects the economy.11 2005 Pearson Education Canada Inc.Monetary Transmission MechanismsOther Asset
14、 ChannelsTobins q Channel:where MVF=market value of firms and RCC=replacement cost of capital.If q is high,MFV is high relative to RCC,and new plant and equipment capital is cheap relative to the market value of firms.In this case,companies can issue stock and get a high price for it relative to the
15、 cost of the facilities and equipment they are buying.I because firms can buy a lot of new investment goods with only a small issue of stock.The transmission mechanism for monetary policy is M,Pe,q,I,Y where Pe is the price of equity(not the expected price level)12 2005 Pearson Education Canada Inc.
16、Monetary Transmission MechanismsOther Asset ChannelsWealth Channel:Was introduced by Franco Modigliani in his famous“life cycle hypothesis of consumption.”He argued that the most important transmission mechanism of monetary policy involves consumption.Considering that an expansionary monetary policy
17、 stock prices,the wealth transmission mechanism works as follows:M,Pe,W,C,Y Note:Tobins q and wealth mechanisms allow for a general definition of equity that includes housing and land.For example,an in house prices,which their value relative to replacement cost,Tobins q for housing,thereby stimulati
18、ng its production.Also,an in housing and land prices W,thereby C and Y.13 2005 Pearson Education Canada Inc.Credit View This view proposes that two types of monetary transmission channels arise as a result of information problems(such as adverse selection and moral hazard problems)in credit markets.
19、These channels operate through their effects onA.Bank lending,andB.Firms and households balance sheets Note:Adverse selection is an asymmetric information problem that occurs before the transaction occurs:potential bad credit risks are the ones who most actively seek out loans.Moral hazard arises af
20、ter the transaction occurs:the lender runs the risk that the borrower will engage in activities that are undesirable form the lenders point of view.14 2005 Pearson Education Canada Inc.Credit ViewBank Lending Channel:Because of asymmetric information problems in credit markets,many borrowers do not
21、have access to the stock and bond markets and depend on bank loans to finance their activities.Because of banks ability to solve such problems(see Chapter 8),an expansionary monetary policy which bank reserves and deposits,the quantity of bank loans available to small credit-constrained borrowers.Th
22、e in loans causes C and I to.The monetary policy transmission is:M,bank deposits,bank loans,C and I,Y Note:Monetary policy will have a greater effect on spending by smaller firms,which are more dependent on bank loans,than it will on large firms,which can access the credit markets.15 2005 Pearson Ed
23、ucation Canada Inc.Credit ViewBalance Sheet Channel:As we saw in Chapter 8,the lower the net worth(NW)of business firms(and therefore the lower the collateral that they have for their loans),the more severe the adverse selection and moral hazard problems in lending to these firms.In fact,a in NW,the
24、 adverse selection and moral hazard problems and leads to a in lending and hence in I.Monetary policy can affect firms balance sheets in several ways.For example,expansionary monetary policy,Pe(along lines discussed earlier)and the NW of firms and so leads to an in I and Y.The monetary policy transm
25、ission is:M,Pe,adverse selection,moral hazard,lending,I,Y 16 2005 Pearson Education Canada Inc.Credit ViewBalance Sheet ChannelCash Flow Channel:This is another balance sheet channel.It operates through its effects on cash flow,the difference between cash receipts and cash expenditures.Expansionary
26、monetary policy,i and raises cash flow.The in cash flow causes an improvement in firms balance sheets,because it liquidity and makes it easier for lenders to know if the firm will be able to pay its bills.This adverse selection and moral hazard problems,leading to an in lending.Hence,M,i,cash flow a
27、dverse selection,moral hazard,lending,I,Y Note:In this transmission mechanism it is the short-term i(not ir)that affects cash flow.Hence,this interest rate mechanism is different from the traditional interest rate mechanism.17 2005 Pearson Education Canada Inc.Credit ViewBalance Sheet ChannelUnantic
28、ipated Price Level Channel:This is another balance sheet channel,operating through its effects on P.Expansionary monetary policy,produces a surprise in P,lowering the real value of firms liabilities,leaving unchanged the real value of firms assets.This real NW,adverse selection and moral hazard prob
29、lems,leading to an in I and Y.M,unanticipated P,adverse selection,moral hazard,lending,I,Y 18 2005 Pearson Education Canada Inc.Credit ViewBalance Sheet ChannelHousehold Liquidity Effects Channel:The credit view applies equally well to consumer spending,particularly on consumer durables and housing.
30、An in M,i and causes an in durables and housing purchases by consumers who do not have access to other sources of credit.Similarly,i cause an improvement in household balance sheets because they cash flow to consumers.An in consumer cash flow,likelihood of financial distress,which the desire of cons
31、umers to hold durable goods or housing,thus spending on them.Hence,M,Pe,value of financial assets,likelihood of financial distress,consumer durable and housing expenditure,Y 19 2005 Pearson Education Canada Inc.Lessons for Monetary Policy1.Dangerous to associate easing or tightening with fall or ris
32、e 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.20 2005 Pearson Education Canada Inc.