week 8

• the demand for intermediation is downward sloping, and is the XD curve
• Marginal costs are increasing in the volume of lending for financial intermediaries
• the supply of financial intermediation is upward sloping (XS curve)
• at higher Y, credit spread (w) is lower
• increases in aggregate output results in increases in intermediary supply of loans because intermediaries borrow more , which reduces credit spread
• at higher Y, the XS curve shifts down
• Investment is funded by borrowing, so is a function of rb
• with intermediaries, the IS curve is flatter, and more interest elastic
• with financial intermediaries, shifts in the MP curve have larger effects on outputs, in the 'financial accelerator' effect
• as output rises, the financial health of firms and households increases, which means the value of assets they use as collateral increases, making loans less risky, so the interest rate decreases, increasing investment and further increasing investment
• disruption of the credit supply results in shifts in the XS curve, and financial intermediaries supplying less credit at each level of interest rate spread
• disruption of the credit supply causes the IS curve to shift down, as Investment decreases. the Central bank reduces the raving real interest rate, further reducing Y
• In a financial crisis, supply of intermediation reduces so the XS curve shifts left. this is countered by reducing the savings interest rate, but in a crisis the CB is at the zero lower bound, so Y decreases further
• credit spread should be taken into account when setting monetary policy
• MP rate should be lower compared to Taylor rule when there are large credit spreads, due to the ZLB issue
• when dealing with a zero lower bound, unconventional monetary policy to give intermediaries credit on easier terms can be done to inject liquidity and reduce the credit spread
• loan supply is lending that ultimate savers are willing to finance at a given interest rate
• loan supply is upward sloping, as at higher interest rates, savings increases
• loan demand is loans given to lenders at a given interest rate
• the loan-supply schedule assumes key determinant of quantity of loans is interest rate
• If income increases, supply of loans should also increase, because not all of the additional income will be consumed
• if income increases, demand of loans should decrease, as borrowers have more current income to finance consumption
• if the interest rate elasticity is higher for borrowers than savers, the vertical shift in the LS curve is more than the shift in the LD curve for changes to income
• the loan supply and demand schedule results in a downward sloping IS curve
• there are multiple interest rates for borrowing at varying degrees of risk
• intermediaries go between savers and borrowers, and give each group different interest rates
• rs is the interest rate paid to savers by intermediaries
• rb is the interest rate borrowers pay to intermediaries
• rb>rs, due to risk and asymmetric information
• the difference between rb and rs is the credit spread, or interest differential
• The larger the credit spread, the lower the volume of intermediated credit