Monetary Policy 2

Monetary Policy Transmission: Monetary Policy is like a string

It works better to reduce economic activity (pull), than it does to expand an economy (push)

• Loose Links

• Long and Variable Lags

Long-term interest rates that influence spending plans are linked loosely to the federal funds rate. The response of real long-term interest rate to a change in nominal rates depends on changing inflation expectations. The response of expenditure plans to changes in the real interest rate depends on many factors that make the response hard to predict.

The monetary policy transmission process is long and doesn’t always work in the same way.

Sometimes banks fail: (Fall in asset values: shortage of capital Mismanagement, fraud, too much risk, bad loans, insufficient reserves

What happens when the system fails?

If the system has too much leverage, and is highly interconnected, a fill in asset prices can set off a crisis.