Copyright © 2002 Pearson Education, Inc. Macroeconomic Costs of Information Problems Information problems can create obstacles for borrowers who need external financing. Asymmetric information makes it difficult and costly to match savers and borrowers. Information problems typically make external financing more expensive. Investment spending is tied to the amount of a firm’s internal funds.

Copyright © 2002 Pearson Education, Inc. Slide 27-2 Restriction On Bank Lending: The restriction on bank lending reduces the availability of credit to bank- dependent borrowers

Copyright © 2002 Pearson Education, Inc. Slide 27-3 Decline In Borrowers’ Net Worth: Decline in borrowers’ net worth raises information costs and reduces borrowers’ ability to obtain funds at any given interest rate.

Copyright © 2002 Pearson Education, Inc. Financial Panics During the late 1800s and early 1900s, the United States had several financial panics. A financial panic causes the AD curve to shift to the left, resulting in less output. Research has shown that a financial panic increased the severity of the Great Depression.

Copyright © 2002 Pearson Education, Inc. Credit Controls and Credit Crunches A credit crunch is a decline in either the ability or the willingness of banks to lend. In the early 1980s banks had to curtail their lending because of disintermediation. Concerns about balance sheets caused a credit crunch in the recession.

Copyright © 2002 Pearson Education, Inc. The Money Channel The money channel refers to the money supply effects on interest-sensitive components of aggregate demand. Loans by financial institutions play no special role in the money channel. The money channel ignores financial intermediaries’ role in information costs.

Copyright © 2002 Pearson Education, Inc. Slide 27-7 Monetary Expansion Effects in the Money Channel

Copyright © 2002 Pearson Education, Inc. The Bank Lending Channel The bank lending channel emphasizes the behavior of bank-dependent borrowers. A monetary expansion increases banks’ ability to lend. Increases in loans to bank-dependent borrowers increases their spending.

Copyright © 2002 Pearson Education, Inc. Slide 27-9 Monetary Expansion Effects in the Bank Lending Channel

Copyright © 2002 Pearson Education, Inc. The Balance Sheet Channel The balance sheet channel refers to the impact of money supply changes on borrowers’ net worth. A monetary contraction by raising interest rates will lower a firm’s net worth and output. Holdings of liquid assets also reduce the likelihood of financial distress.

Copyright © 2002 Pearson Education, Inc. Slide Monetary Expansion Effects in the Balance Sheet Channel: The Fed increases the money supply, raising the real money supply in the short run. The real open market interest rate falls initially from r 0 to r 1. Aggregate demand rises because of an increase in interest-sensitive spending and because of the rise in net worth. These effects raise money demand and the real interest rate rises.