Capital-market Imperfections, Investment, and the Monetary Transmission Mechanism

Understanding the channels through which monetary policy affects investment and other economic variables has long been a key research topic in macroeconomics. At an operational level, a “tightening” of monetary policy by a central bank implies a sale of bonds by the central bank and an accompanying reduction in bank reserves. One question for debate in academic and public policy circles is whether this exchange between the central bank and the banking system has consequences in addition to those for the open market interest rates. At the risk of oversimplifying the debate, the question is often asked as whether the traditional interest rate or “money view” channel presented in most textbooks is augmented by a “credit view” channel. In this paper, I argue that the terms “money view” and “credit view” are not always well defined in theoretical and empirical debates over the monetary transmission mechanism. Recent models of information and incentive problems in financial markets suggest the usefulness of decomposing the transmission mechanism into two parts: one related to effects of policy-induced changes on the overall level of real costs of funds, and one related to “financial accelerator” effects stemming from impacts of policy actions on the financial positions of borrowers or intermediaries. The results described here suggest that the investment decisions of a significant group of borrowers are influenced by their balance sheet conditions. Ascertaining whether a bank-lending channel is operative, however, requires additional research using individual borrower-lender transactions. The strength of these alternative channels of monetary policy varies across countries according to differences in the interest sensitivity of spending and differences in financial structure. R. Glenn Hubbard Department of Economics and Graduate School of Business Columbia University 609 Uris Hall; 3022 Broadway New York, NY 10027 U.S.A. (1)(212)854-3493 [email protected]