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Revisiting the Financial Accelerator Hypothesis

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

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Revisiting the Financial Accelerator Hypothesis

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

  2. 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

  3. 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

  4. 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”

  5. 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

  6. Coverage Ratio

  7. 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

  8. Bank Lending Channel

  9. Mortgage Burdens and MP

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

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