Connecting The Dots : Policy And The Credit Channel

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Connecting the Dots: Policy and the Credit Channel Post 2008 The Fed injected an unprecedented amount of liquidity into the financial system so why are banks holding on to so much excess reserves. As discussed earlier, reserve levels have shot up and counter intuitively loans, especially C&I loans have plummeted. The bank-lending channel would lead us to believe that an increase in reserves would lead to an increase in loans. The balance sheet channel would point to low interest rates strengthening balance sheets and promoting lending. This has yet to occur, could it be that the credit channel could be temporarily closed? It is possible that economic events that preceded the monetary policy ‘shock’ treatment may have altered the ‘normal’ transmission mechanisms. A financial crisis is such an event and as a result, it is reasonable to expect that the transmission of monetary policy throughout the recent financial crisis differed significantly from the periods which have preceded it. To uncover what is going on now we should begin by explain the current state of the money multiplier. If banks either are unable or choose not to lend deposited funds, this will result in both a decline in the money multiplier and a rise in the excess reserves held by banks. This is exactly the situation that is currently playing out. As you can see from Graph Five, since 2009 the money multiplier has been equal to or below one. This has not occurred since the Great Depression and is a

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