Mechanisms of monetary transmission – credit channel

A second way through which the credit channel has been advanced to transmit monetary policy effects to various sectors is explained by the bank-lending theory. By affecting banks’ stock of lending funds, the monetary policy is argued to control intermediated credit supply thus limiting the funds available to investors (Bernanke 2007, June 15). The model takes into account the role of deposits especially for small financial institutions as the primary provider of money that is lent out to borrowers. Monetary policies in most cases the open market operations whose primary result is limiting the supply of bank reserves would thus have a subsequent effect of constraining the bank deposit of such deposit fueled lending institution so as to avail adequate funds for withdraw transactions (Mateut, Bougheas & Mizen, 2006).  In the oil industry these two mechanisms of credit channel could also explain for the impacts (Reuters, 2008, November 6) noted following the 2007/08 financial crisis and the monetary policies that were subsequent applied. Scale backs and delays of projects that had been planned in advance was the foremost real effect that the financial crisis and associated measures had helped bring out. Such effect could be thought of as resulting from in availability of funds to ensure completion of the projects without compromising the running operations of the corporations. Banks that for instance are funded mainly by deposits could not take risks of lending substantial amounts following depositors withdraw of huge amounts due to collapse of a lot of the banks in the wake of the 2007/8 banking crisis. Through these transmission mechanisms the monetary policy adopted can have different effects to the economic situation of the country and some are credited for resulting into a stabilizing effect (Boivin, & Giannoni, 2003). The theories however take cognizance of certain conditions that must be inherent or follow policy traits for the real effect to the economy to be the probable result.

Monetary transmission theories however must take into account a number of assumptions for them to be realistic explainers of how central bank instituted policies result into actual economic impacts. Ireland (2005) for instance delineates the characteristics that monetary policy-induced movements must possess for them to have an impact far advanced than altering the balance sheets of the central banks responsible. One of the proposals is that other agents must be unable to compensate for the effects of the policy by ways such as issuance of private securities that would act as perfect substitutes for the elements of the monetary base (Ireland, 2005). Thus for such assumptions to be plausible restrictions such as laws that curtail the issuance of liabilities that exhibit at least one of the traits of the currency and bank reserves must be operating (Ireland, 2005). But since both elements of the monetary base (currency and bank reserves) have nominal denominations being quantified according the economy’s unit of account policy generated changes in the nominal monetary base can only generate actual economic effects if the nominal prices are rendered incapable of immediately responding to the changes that would result into the real value of the monetary base remaining as it was before the change (Ireland, 2005). Monetary transmission theories thus assume that some friction in the economy must exist to render the normal prices from immediate adjustment to the changes in the monetary base (Ireland, 2005).  In such a respect and in relation to the energy sector then association of increasing oil prices to economic down turns can provide a pointer (Chen, 2009). Go to the financial accelerator theory.

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