Sunday, May 08, 2011

The interest rate channel

As I have maintained for some time on this blog, the interest rate channel of monetary policy is broken. Credit activity and bank lending (the primary sources of money creation) have been grinding lower. In this case, raising interest rates would create INFLATIONARY pressures due to increased interest income and also increasing non variable COSTS for firms. This effect is exacerbated by the fashion of modern finance with regard to short-term financing and the current vogue of the Corporate Treasurer as profit center. In other words, most firms are very lean, with massive dependence on external financing to achieve Positive Net Present Value project goals.

It is a strange and unprecedented set of circumstances.

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