“Monetary policy doesn’t work through the interest rate channel—interest rates don’t matter.” Economists, argues Thornton, started believing in the power of interest rates in transmitting monetary policy after Volcker succeeded in bringing an end to the Great Inflation of 1970’s. But in the 90’s research by Ben Bernanke and Mark Gertler started questioning this belief. Fast forward 20 years, new research by Steve Sharpe and Gustavo Suarez confirms that the interest rate channel is very weak. Policymakers, concludes Thornton, need to “undertake a realistic appraisal of the extent to which changes in interest rates affect spending.”
The Limits of Monetary Policy: Why Interest Rates Don’t Matter
By: Daniel Thornton – Former VP Federal Reserve Bank of St LouisCochrane agrees that interest rates are not very important for investment. He suggests to look at investments as being strongly influenced by “stock prices, by the risk premium in the cost of capital.”
“ME/BE is the market to book ratio of the stock market, or “Q.” P/(20xD) is the ratio of price to 20 x Dividends. IK is the ratio of investment to capital.”
Thornton on interest rate humility
By: John Cochrane – Stanford University
New research
Belongia and Ireland develop a structural vector autoregressive time series model and show that changes in real money balances play a key role, alongside movements in real interest rates, in transmitting the effects of monetary policy to real GDP. They argue that it is changes in nominal money growth that better signal whether monetary policy is expansionary or contractionary.
A Classical View of the Business Cycle
Authors: Michael T. Belongia, Peter N. Ireland
From: University of Mississippi – Boston College
Hofmann and Peersman find that since the mid-80s housing and credit markets have played a key role in monetary policy transmission. In particular, monetary transmission through residential investment and noncorporate non-residential investment has become stronger.
Monetary Policy Transmission and Trade-offs in the United States: Old and New
Authors:Boris Hofmann, Gert Peersman
From: BIS – Ghent University
Picture by CNBC
