Financial Update (Third Quarter 2007)

In Atlanta, Bernanke Discusses Monetary Policy, Finance

Ben BernankeAddressing a June conference at the Atlanta Fed on "The Credit Channel of Monetary Policy in the 21st Century," Federal Reserve Chairman Ben Bernanke took his listeners on what he called "a whirlwind tour of several decades of research on how variations in the financial condition of borrowers, whether arising from changes in monetary policy or from other forces, can affect short-term economic dynamics."

Explaining the economy's fluctuations
Speaking to Federal Reserve and academic economists as well as central bankers, Bernanke summarized several research concepts. One is the financial accelerator effect, whereby a real shock can "lead to persistent fluctuations in the economy, even if the initiating shock had little or no intrinsic persistence."

This concept, Bernanke noted, "can help to explain the persistence and amplitude of cyclical fluctuations in a modern economy." In addition, "financial accelerator effects need not be confined to firms and capital spending but may operate through household spending decisions as well."

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Bank loans feel the channel's changes
Bernanke traced these ideas through research on monetary policy effects, discussing, in particular, the theory of the bank-lending channel. This theory "holds that monetary policy works in part by affecting the supply of loans offered by depository institutions," he explained.

"The critical idea is that the cost of funds to borrowers depends inversely on their creditworthiness, as measured by indicators such as net worth and liquidity," Bernanke said. Endogenous changes in creditworthiness may increase the financial accelerator effect and strengthen the influence of the credit channel.

The conference assembled economists from the Atlanta Fed, other regional Federal Reserve banks, the Fed Board of Governors, the Bank of Japan, the European Central Bank, and universities around the world.

July 16, 2007