Revisiting the Financial Accelerator Hypothesis

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Presentation transcript:

Revisiting the Financial Accelerator Hypothesis EH 447, 2008/9 Week 5-1 Albrecht Ritschl

Why Should Demand React to Monetary Policy Changes? Traditional: effects on cost of capital BUT Monetary policy affects short term interest rates Finding empirical effects of interest rates on investment is difficult If anything, MP has effects on demand for long lived assets

Financial Accelerator MP may effect external finance premium, i.e. cost of debt vs. equity or retained earnings Two financial channels of monetary policy transmission Balance sheet channel Bank lending channel

Balance Sheet Channel (1) Debt finance premium negatively related to debtor’s net worth Liquid assets Marketable collateral Business cycle shocks on balance sheets amplify the business cycle “Financial accelerator”

Balance Sheet Channel (2) Monetary policy affects Short term borrowing cost Asset values Measure this by “coverage ratio”, relation of interest payments by nonbank firms to total interest and profit payments

Coverage Ratio

Bank Lending Channel Monetary policy may influence bank lending to firms Reduction in supply of bank credit likely to have negative real effects Restrictive open market policy would reduce bank deposits and result in credit crunch

Bank Lending Channel

Mortgage Burdens and MP

How Do these Things Look Like for the Great Depression? Data projects Econometrics projects