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Chapter 26: Q.11 (page 691)

Nobel Prize winner Franco Modigliani found that the most important transmission mechanisms of monetary policy involve consumer expenditure. Describe how at least two of these mechanisms work.

Short Answer

Expert verified

The transmission mechanism of monetary policy is the method by Franco Modigliani. It reduces the cost of financing durable goods by lowering the interest rate. An expansionary monetary policy reduces interest rates and the cost of financing durable goods, resulting in more consumer durable goods consumption.

It boosts the stock market's value and riches.

Step by step solution

01

Step 1. Concept of transmission mechanism of monetary policy 

The transmission mechanism of monetary policy is the method by which monetary policy impacts general economic circumstances and asset price levels.

02

Step 2. Explanation

The following is the procedure for two significant monetary policy transmission mechanisms:

It lowers the interest rate and the cost of financing durable items. An expansionary monetary policy lowers the rate of interest and the cost of financing durable goods, increasing consumer durable goods spending.

It raises the stock price and wealth. An expansionary monetary policy raises stock and wealth prices, increasing the number of resources available to consumers and thereby increasing consumption.

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Most popular questions from this chapter

Following the global financial crisis, mortgage rates reached record-low levels by 2013 and again in 2016 .

a. What effect should this have had on the economy, according to the household liquidity effect channel?

b. During much of this time, most banks raised their credit standards significantly, making it much more difficult to qualify for home loans and to refinance existing loans. How does this information alter your answer to part (a)?

A "rate cycle" is a period of monetary policy during which the federal funds rate moves from its low point toward its high point, or vice versa, in response to business cycle conditions. Go to the St. Louis Federal Reserve FRED database, and find data on the federal funds rate (FEDFUNDS), real business fixed investment (PNFIC96), real residential investment (PRFIC96), and consumer durable expenditures (PCDGCC96). Use the frequency setting to convert the federal funds rate data to "quarterly," and download the data.

a. When did the last rate cycle begin and end? (Note: If a rate cycle is currently in progress, use the current period as the end.) Is this rate cycle a contractionary or an expansionary rate cycle?

b. Calculate the percentage change in business fixed investment, residential (housing) investment, and consumer durable expenditures over this rate cycle.

c. Based on your answers to parts (a) and (b), how effective was the traditional interest rate channel of monetary policy over this rate cycle?

If adverse selection and moral hazard increase, how does this affect the ability of monetary policy to address economic downturns?

How does the Great Depression demonstrate the unanticipated price level channel?

1. Go to http://www.econlib.org/library/Encl/Recessions . html and review the material on recessions.

a. What is the formal definition of a recession?

b. What are the problems with the definition?

c. What are the three Ds used by the National Bureau of Economic Research (NBER) to define a recession?

d. Review Chart 1. What trend is apparent regarding the length of recessions?
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