The Changing U.S. Financial
System: Some Implications for the
Monetary Transmission Mechanism
By Gordon H. Sellon, Jr.
An important part of monetary policy is the monetary transmission
mechanism, the process by which monetary policy actions
influence the economy. While the transmission mechanism
involves a number of channels, including exchange rates, bank credit,
and asset prices, most economists consider interest rates to be the principal
avenue by which monetary policy affects economic activity. In a simple,
stylized view of the interest rate channel, monetary policy first
influences bank lending rates and short-term market interest rates.
Changes in short-term rates are then transmitted to long-term rates.
Finally, economic activity responds as businesses and consumers react to
these changes in interest rates.
The influence of monetary policy on interest rates depends importantly
on the structure of the financial system. In recent decades, significant
changes in the structure of financial markets and institutions in the United
States may have altered the interest rate channel. Key developments
include the deregulation of the financial system, the growth of capital markets
as an alternative to bank intermediation, increased competition among
intermediaries both domestically and internationally, and greater transparency
by the Federal Reserve about monetary policy operations.
Gordon H. Sellon, Jr. is a vice president and economist at the Federal Reserve Bank of Kansas
City. This article is on the bank’s website at www.kc.frb.org.
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6 FEDERAL RESERVE BANK OF KANSAS CITY
These changes in the financial system may have altered both the
timing and magnitude of the response of interest rates ...