Lehman, PSI and the consequences of credit policy: The third lever of macroeconomics

Posted: May 2, 2013 in economy
Tags: , ,

Economics undergrads learn early on about two levers to manage the macroeconomy: fiscal policy and monetary policy. Events of the last five years make clear that there is a third lever that while poorly understood and difficult to model, it is at times critical: credit policy.By credit policy (or banking policy or financial policy) I mean anything that affects how the financial system influences aggregate demand. Of course, we’ve always known aggregate demand depends on both the central bank’s policy rate and the spread over that rate paid by households and firms. But before the cirisis the relationship between the policy rate and what borrowers paid was assumed to be either constant, or endogenous to monetary policy or the business cycle.That this is not always true is the greatest lesson macroeconomists have learned from the crisis. The role of credit policy is critical to understanding the current state of Europe’s economy. My colleague’s Free Exchange column in this week’s issue and accompanying leader explore why businesses in Spain and Italy pay so much more to borrow than businesses in Germany even though they share a common currency and monetary policy. The column notes how Mark Gertler and Ben Bernanke identified the “bank lending channel” as a critical variable in the transmission of monetary policy. Put simply, low interest rates won’t boost demand if the …

via Economic Crisis http://www.economist.com/blogs/freeexchange/2013/05/lehman-psi-and-consequences-credit-policy?fsrc=rss

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