Title: The Changing U.S. Financial System: Some Implications for the Monetary Transmission Mechanism
Abstract: An important part of monetary policy is the monetary transmission mechanism, the process by which monetary policy actions influence the economy. While the transmission mechanism involves a number of channels, including exchange rates, bank credit, and asset prices, most economists consider interest rates to be the principal avenue by which monetary policy affects economic activity. In a simple, stylized view of the interest rate channel, monetary policy first influences bank lending rates and short-term market interest rates. Changes in short-term rates are then transmitted to long-term rates. Finally, economic activity responds as businesses and consumers react to these changes in interest rates. The influence of monetary policy on interest rates depends importantly on the structure of the financial system. In recent decades, significant changes in the structure of financial markets and institutions in the United States may have altered the interest rate channel. Key developments include the deregulation of the financial system, the growth of capital markets as an alternative to bank intermediation, increased competition among intermediaries both domestically and internationally, and greater transparency by the Federal Reserve about monetary policy operations. These changes in the financial system may have altered both the timing and magnitude of the response of interest rates to monetary policy. Indeed, the failure of long-term interest rates to respond to monetary policy easing during the past year has been cited in the financial press as an indication that monetary policy may now have less influence on interest rates than in the past. This article examines how the chaning financial system has affected the interest rate channel of monetary policy. The article finds that the response of interest rates to monetary policy, rather than diminishing, has actually increased considerably over time. Indeed, bank lending rates on consumer and business loans and mortgage rates now appear to exhibit a much stronger and faster response to monetary policy actions than in the past. Moreover, institutional changes, such as the increased use of variable-rate loans and the availability of low-cost mortgage refinancing, may have altered the transmission mechanism, potentially broadening the influence of monetary policy on the economy. The first two sections of the article describe the traditional view of the monetary transmission mechanism and identify important changes in the financial structure that may have altered the interest rate channel. The third section shows how the response of bank lending rates on business and consumer loans to monetary policy actions has changed and explores possible reasons for these changes. The fourth section examines major developments in mortgage markets and their implications for the monetary transmission mechanism. The fifth section discusses the overall effect of the changing financial system for monetary policy. The final section provides a summary and conclusions. I. THE INTEREST RATE CHANNEL OF-MONETARY POLICY In the traditional view of the monetary transmission mechanism, the banking system and interest rates play key roles in determining how the economy responds to monetary policy.I Changes in monetary policy typically start in the banking system when a central bank alters the supply of bank reserves to influence a short-term interest rate. In the United States, for example, the Federal Reserve determines a desired level of the overnight interbank federal funds rate and maintains this rate by altering the supply of bank reserves. Changes in monetary policy are implemented by raising or lowering the intended federal funds rate. These monetary policy actions are transmitted to the economy to the extent that changes in the intended federal funds rate pass through to other interest rates and to the extent that these interest rate changes alter consumer and business spending. …
Publication Year: 2002
Publication Date: 2002-01-01
Language: en
Type: article
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Cited By Count: 84
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