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Chapter 26: Q.12 (page 691)

In the late 1990 s, the stock market was rising rapidly, the economy was growing, and the Federal Reserve kept interest rates relatively low. Comment on how this policy stance would affect the economy as it relates to the Tobin q transmission mechanisms.

Short Answer

Expert verified

Tobin's q predicted that when inflation goes up and borrowing costs remain low, capital will rise, resulting in increased aggregate demand. Stock price increases will improve customer wealth, resulting in greater spending and inflationary pressures.

Step by step solution

01

Concept Introduction.

The mechanisms whereby the Federal Reserve System's monetary policies affect macroeconomic development are known as monetary policy channels.

02

Explanation of solution.

Tobin is the one to describe the relationship between economic growth and expenditure, and his reasoning is known as Tobin's q. Considering Tobin's q and the impact of affluence on expansionary monetary policy, we have a consistent condition. Given low-interest rates and higher stock values, Tobin's q predicted that capital would rise, resulting in increased aggregate demand.

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Most popular questions from this chapter

Why does the credit view imply that monetary policy has a greater effect on small businesses than on large firms?

"If the fed funds rate is at zero, the Fed can no longer implement effective accommodative policy." Is this statement true, false, or uncertain? Explain.

A "rate cycle" is a period of monetary policy during which the federal funds rate moves from its low point toward its high point, or vice versa, in response to business cycle conditions. Go to the St. Louis Federal Reserve FRED database, and find data on the federal funds rate (FEDFUNDS), real business fixed investment (PNFIC96), real residential investment (PRFIC96), and consumer durable expenditures (PCDGCC96). Use the frequency setting to convert the federal funds rate data to "quarterly," and download the data.

a. When did the last rate cycle begin and end? (Note: If a rate cycle is currently in progress, use the current period as the end.) Is this rate cycle a contractionary or an expansionary rate cycle?

b. Calculate the percentage change in business fixed investment, residential (housing) investment, and consumer durable expenditures over this rate cycle.

c. Based on your answers to parts (a) and (b), how effective was the traditional interest rate channel of monetary policy over this rate cycle?

Why might the bank lending channel be less effective today than it once was?

1. Go to http://www.econlib.org/library/Encl/Recessions . html and review the material on recessions.

a. What is the formal definition of a recession?

b. What are the problems with the definition?

c. What are the three Ds used by the National Bureau of Economic Research (NBER) to define a recession?

d. Review Chart 1. What trend is apparent regarding the length of recessions?
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