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6. Bank LendingExpansionary monetary policy => increasing bank deposits => rising bank loans => rising business investment and
consumer spending => rising output
7. Balance SheetExpansionary monetary policy => higher stock prices =>higher firm net worth => lower adverse selection and moral hazard
=> higher business lending => greater investment => rising output adverse selection = potential bad credit risks are the ones who most actively seek out loans
moral hazard = the lender runs the risk that the borrower will engage in risky activities that make it less likely that the loan will be paid back
balance sheet => lower adverse selection and moral hazard => higher business lending => greater investment => rising output
9. Unanticipated Price LevelExpansionary monetary policy => unanticipated increase in prices => reduces real value of firm’s liabilities => higher real
net worth => lower adverse selection and moral hazard => higher business lending => greater investment => rising output
Weak fundamentals are restricting sales:Few new jobs, low income growth, high unemployment, low and volatile wealth, limited access to credit, deleveraging and low confidence consistent with a deep recession.Factors supporting consumer spending:Private sector job growth, consumer are fixing their budgets, falling debt payments through debt reduction and refinancing, consumers who have stopped making mortgage payments but not yet defaulted have extra cash.
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Demand side factors:1.Affordability is high2.Large pent up demand for homes3.Low mortgage interest rates, but tight credit and some households suffer from inpaired credit4.Rising investor and consumer confidence5.Modest job and income growth
Supply-side factors:1.Falling inventory of homes (“underwater” households are reticent to list home)2.Falling distressed homes available for sale3.Lack of new home inventory
•Surging non-revolving credit (financing for big ticket items)•Rising auto loans due to strong auto sales•Rising government-backed student loans ($500 billion, 1/5 of total consumer credit).• debt => spending => Y/Y•Stagnant revolving credit (credit card) due to relatively high borrowing rates, but credit standards are looser.
Supply Side of Credit•Cheaper financing and better access to credit has released pent-up demand.
Demand Side of Credit•Better labor market => improving financial positions (ability) => rising consumer confidence (willingness) => credit financed consumption
Deleveraging = 1/3Charge-off = 2/3
Household Debt Service &Financial Obligations Ratios
The household debt service ratio is an estimate of the ratio of debt payments to disposable personal income. Debt payments consist of the estimated required payments on outstanding mortgage and consumer debt.
The debt service ratio fell to 10.61% in the third quarter of 2012, the lowest level since Q3 of 1994. Falling interest rates and debt levels both caused the decline.Low debt payments are freeing up disposable income for additional consumption or savings.
The financial obligations ratio adds automobile lease payments, rental payments on tenant-occupied property, homeowners' insurance, and property tax payments to the debt service ratio.
The financial obligation ratio fell to 15.74% in the third quarter of 2012, down from 18.9% in Q3 of 2007.
Lessons for Monetary Policy
1. Dangerous to associate easing or tightening with fall or rise in nominal interest rates.
2. Other asset prices besides short-term debt have information about stance of monetary policy.
3. Monetary policy effective in reviving economy even if short-term interest rates near zero.
4. Avoiding unanticipated fluctuations in price level important: rationale for price stability objective.