Academic journal article Review - Federal Reserve Bank of St. Louis

Commentary on "Is There a "Credit Channel" for Monetary Policy?"

Academic journal article Review - Federal Reserve Bank of St. Louis

Commentary on "Is There a "Credit Channel" for Monetary Policy?"

Article excerpt

Glenn Hubbard's paper considers what is perhaps the most basic question in monetary economics: How does monetary policy "work"? It suggests that informational frictions affecting capital markets create additional mechanisms--beyond those of conventional textbook models--through which monetary policy operates. In particular, Hubbard suggests that "realistic models of financial constraints on firms' decisions imply potentially significant effects of monetary policy beyond those working through conventional interest rate channels." Now I personally feel that there are a number of serious issues about what these "conventional interest rate channels" are,(1) but that takes us beyond the scope of the present paper. So, for the purpose of discussion, let's imagine that we accept that there are such channels,(2) and consider how the presence of financial constraints impacts the scope for monetary policy to have other effects.

As the previous quotation suggests, there ought to exist models in which there are informational (or other) frictions affecting firm investment decisions, and in which there is scope for monetary policy to operate. This requires a model with--at a minimum--money, capital and a credit market friction. Moreover, I would argue that an interesting model for analyzing the role of monetary (or other) policies in an economy with a financial market friction should be a general-equilibrium model, since we would like to know the answers to at least two questions: not only

(1) What can monetary policy do? but also,

(2) What should monetary policy do? (That is, what are the welfare implications of alternative methods of conducting monetary policy?)

While the Hubbard paper cites any number of references on financial market imperfections and their effects on firm investment behavior, to my knowledge none of the papers he cites presents a general-equilibrium model of an economy with money, capital and a credit market friction. So, at this point, I have the following questions:

* What are the models of financial constraints implying these magnified effects of monetary policy (presuming, of course, the need for general-equilibrium models)?

* What are the implications of these models for the effects (and welfare consequences) of various methods for conducting monetary policy?

The Hubbard paper comes in two parts: Its appendix contains a suggestive model of a single firm undertaking credit-financed investment, subject to a moral hazard problem, along with a proposed list of empirical implications derived from the literature that the model represents. The text of the paper presents a discussion of the empirical literature on how monetary policy does (or can) affect the investment behavior of individual firms. To a large extent, I very much like both the model of the paper and the discussion of the empirical evidence. I do think, however, there is a serious question about how these two parts of the paper fit together. Let me therefore add to my list of questions:

* If we do have general-equilibrium models of capital accumulation in the presence of money and financial market frictions, what do these models imply about the consequences of various monetary policy actions?

* What is (or could be) the empirical evidence on these implications?

* How does the empirical evidence discussed in the Hubbard paper bear on them?

Before proceeding to a discussion of these issues, let me say that I intend to focus my discussion most where the Hubbard discussion focuses least--on the theoretical aspects of monetary growth models with informational frictions. In large part, this is because Glenn is a pioneer in, and a major continuing contributor to, the empirical literature on these topics, and his discussion of this literature is thoughtful and easy to follow. Thus, while admitting Glenn may have absolute advantage along both dimensions, considerations of comparative advantage suggest that I should primarily concentrate on theoretical issues. …

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