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Enclosed for your review is a special issue of the Federal Reserve Bank of New Yorks Economic Policy Review devoted to the proceedings of the conference Financial Innovation and Monetary Transmission, held at the Bank on April 5 and 6, 2001.
The overall finding of the conference is that financial innovation, the evolving behavior of firms, and changes in the conduct of monetary policy have altered the ways in which monetary policy affects the economy. At the conference, participants exploredwhether financial innovation in recent years has affected the monetary transmission mechanism, either by changing the ultimate impact of monetary policy or by altering the channels through which it operates.
The economists from central banks, universities, and the private sector who participated investigated three reasons why they believemonetary transmission has changed recently. First, they looked at the impact of the financial innovations that motivated the conferencesuch as the growth of asset securitization, shifts between sources of financing for residential investment, or changes in the strength of wealth effects; second, if a change in the waymonetary policy is conducted explains what appears to be a change in policys effectiveness, when in fact policy has become more effective in reducing economic fluctuations; finally, whether the fundamental structural changes affecting the economys stability (and by implication, monetary transmission) may be due to nonfinancial factors, such as improved inventory management.
Among the main conclusions of the papers presented were:
Financial innovation is one likely reason for the apparent changein the monetary policy transmission mechanism in recent decades. Yet, improved inventory management and the conduct of monetary policy itself may also account for what appears to be a change in the transmission mechanism.
There is no evidence that the quantitative importance of either the wealth channel or the credit channel has changed much in recent years. Despite banks declining role in credit formation, bank credit standards still have a significant effect on loan growth and economic activity. The contribution of the wealth channel to the impact of monetary policy has always been modest, and that contribution has actually decreased in recent decades.
The nations housing sector is no longer a leading indicator of monetary policys effects, owing largely to financial innovation and institutional changes in the housing finance industry.
Neither the consolidation and globalization of the financial services industry nor the shrinking volumes in the reserves market appear to be a major factor affecting monetary transmission.