Securitization and the Efficacy of Monetary Policy. (Session 3: Financial Markets and Institutions)

By Estrella, Arturo | Federal Reserve Bank of New York Economic Policy Review, May 2002 | Go to article overview

Securitization and the Efficacy of Monetary Policy. (Session 3: Financial Markets and Institutions)


Estrella, Arturo, Federal Reserve Bank of New York Economic Policy Review


I. INTRODUCTION

While there is no single prevailing view of the monetary policy transmission mechanism, the credit markets are important in practically every mainstream view. The central bank is seen to influence the economy by affecting the pricing or the volume of credit instruments, or of financial assets more generally. At the same time, the credit markets are significantly influenced by securitization, particularly since a boom in mortgage securitizations took hold of the markets in the 1970s. The pace of that boom has since moderated, but the growth of securitization in other credit markets has been at least as vigorous in the past five years as it was in the mortgage markets two decades ago.

This paper investigates whether the cyclical effects of monetary policy have been influenced by the secular growth in securitization in recent decades. In particular, when the central bank makes a specific monetary policy move--such as increasing the overnight interbank rate by 50 basis points--is the ultimate effect on GDP different from what it would have been in the 1960s, when securitization was virtually nonexistent?

This question is considered from several angles. In Section II, we consider why, in principle, securitization may affect the results of a policy move. The analysis suggests that securitization has likely weakened the impact of any policy move. Alternatively, for policy to achieve a given intended result in terms of inflation or output, it may be necessary to make a larger policy move than was required earlier.

Section III describes the markets in which securitization has grown the most in recent years. The analysis suggests that the more prominently these markets feature in the monetary transmission mechanism, the more likely it is that they have contributed to a reduction in the efficacy of policy moves. We then construct in Section IV some simple empirical macroeconomic models with an explicit role for the level of securitization in the mortgage markets. These markets present the best opportunity to identify empirically the conjectured theoretical effects of securitization because they provide the longest-running time series of data in any securitized market. In the final section, we summarize the lessons derived from the various strands of the analysis.

II. SECURITIZATION AND THE TRANSMISSION MECHANISM: WHY SHOULD SECURITIZATION MATTER?

Casual reasoning suggests that if monetary policy operates through the credit markets, and if securitization has transformed the credit markets over the past few decades, securitization may have had important effects on the transmission mechanism. In this section, we consider how those effects may have manifested themselves. In this discussion, we focus on two types of theories of the importance of these effects, which we classify as pertaining to the liquidity channel or the credit channel.

Liquidity channel theories emphasize the deepening of credit markets as a result of securitization, and draw conclusions about how the functioning of those markets may improve with this deepening and the associated additional liquidity. A classic paper in this literature is Black, Garbade, and Silber (1981). The authors present a model in which the "marketability" of Government National Mortgage Association (GNMA) securities increases as the GNMA market grows. (1) This additional marketability influences the demand for both GNMA securities and directly held Federal Housing Administration (FHA) mortgages, which are gross substitutes. The conclusion they highlight is that these changes tend to lead to lower interest rates in both the GNMA and the FHA markets.

More generally, however, this deepening and increased marketability suggest that the markets would be more efficient in the allocation of credit, and the additional liquidity would reduce undesirable distortions in these markets. Some of these distortions could he simple short-term fluctuations in pricing and credit availability owing to illiquidity. …

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