2 pages

Student Name:________________

1. Article Title, Author, Date and Source:

Transmission Unaccomplished, John Authers September 24 th 2010 Financial Times Page 12

2. Article Summary:

“Transmission Unaccomplished” written in the Lex section of Friday’s Financial Times

offers an interesting and simplified perspective of the complex and sophisticated purpose and

workings of monetary policy. At a time when the world is reeling from the effects of

misunderstood monetary policy in the United States and other nations around the globe, this

article clearly cuts to the heart of the matter, provides a simple, easy to understand analogy

relating monetary policy to an automobile. The authors describe the key moving parts of the

economy as they correlate to their counterparts in an automobile. While he labor and

resources constitute the fuel of the economy, technology and institutions correspond to the

engine, and commerce is depicted as wheels. The financial system is the transmission,

responsible for moving the power and energy created by the fuel and engine to the wheels.

This simple analogy helps frame the context for the reason why central bankers – the

transmission mechanics – were facing increasing difficulty. In particular, the 1.6 % drop in

the dollar’s value, the lack of real economic turn-around, and the lagging increase in GDPs

around the world. The authors seem to think the US, despite an increasing saving rate and

10% deleveraging, still has long ways to go on the road to recovery, and the automobile

analogy suggests, is in need of significant repairs and rebuilding before it is truly road worthy.

3. How is the article is related to the readings and class discussions?

The concepts in the article mesh with the readings in chapters 3 – 5 as a current, real world

depiction of how monetary policy influences decisions in economics. The article highlights the

need for central bankers to properly manage monetary policy in order to maintain the

transmission of the vehicle, and keep the proper amount of power moving from the motor to the

wheels. It questions the true value of quantitative easing, and highlights the ramifications of

pursuing excessive QE as a policy. Just as was discussed in the first five chapters of the text

book, monetary policy involves a delicate balance of adjusting interest rates, setting currency

value, and establishing guidelines that enable prosperity and growth. The article also identifies

too much intervention as a possible means for enhancing the problems we face, rather than

ameliorating the problems.

4. What did I learn from this article?

This article certainly helped put monetary policy, something I seem to be familiar with only

through studying politics and economics, into a very concise, easy to understand framework that

enables a deeper understanding of greater associated issues. I learned that the US liabilities are

Student Name:________________

roughly 120% of disposable incomes, double those of the 1960’s through 1980’s – an era with

some economic growth, and substantial economic faltering, namely price controls, economic

limiting, inflation, and high interest rates. I also learned/confirmed my assumption that the end

of the recession in the US is out of sight due to excessive government intervention.

5. New Terms and Concepts and Brief Explanations:

I came across with the terms “Quantitative Easing” and “Trade Weighted Exchange Rate” that I was not

entirely familiar with. I found the following descriptions for these concepts.

Quantitative Easing: A government monetary policy used by central banks to increase the money supply

by buying government securities or other securities from the market. Net effect: QE increases the money

supply by flooding financial institutions with capital in an effort to promote increased lending and

liquidity. Used when interest rates have been lowered to near 0% and failed to produce results. Although

QE increases liquidity and availability of capital, if demand doesn’t match supply, higher prices and

inflation are likely. (Investopedia.com)

Trade-weighted: A representation of the foreign currency price of the US dollar or the export value of

the US dollar. Increase in the index means the value of the dollar increases. Americans can therefore

more easily afford imports, however, US exports can be more expensive. (investopedia.com)

SOLUTION 13,498

At zero nothing moves any more

Sources: Thomson Reuters Datastream; Haver Analytics

Effective US Federal Funds rate (%)

Recession

1958 70 80 90 2000 10 0

5

10

15

20

1952 60 70 80 90 2000 10 0

2

4

6

8

10

12

14

20

40

60

80

100

120

140

Personal saving (as % of personal disposable income)

Household debt (as % of personal

disposable income)

Transmission unaccomplished The financial system is not the fuel that drives an economy. That role is played by labour and resources. It is not the motor that creates prosperity – technology and institutions do that. Finance is more like the transmission that moves the energy to the wheels of commerce – hopefully at the right speed. But the transmission cannot help when the wheels are stuck in the mud. That analogy may help explain the difficulties faced by central bankers, the stewards of monetary transmission. Financial markets do respond to prodding. A slight change in the Federal Reserve’s wording on Tuesday pushed the dollar down 1.6 per cent on a trade-weighted basis. A new quantitative easing programme could well push asset prices higher. But huge monetary efforts, near-zero rates and whatever-is-needed support for the financial system have not put the real economy back on the growth road. Gross domestic product in most developed economies is still below the 2007 peak, a much worse record for monetary policy than in past recessions. Two years of very low policy rates and asset purchases in developed

countries (two decades in Japan) may be generating monetary energy, but it is being lost in transmission. US consumers appear stuck in the mire for years to come. According to the Bureau of Economic Affairs, their liabilities are still about 120 per cent of disposable incomes, down from 130 per cent before the credit crunch hit. They have much deleveraging to go before this ratio falls to the 66 per cent typical from the 1960s to the 1980s. Their saving

rate has already jumped since the crisis, from barely 1 per cent to 6 per cent today. With little demand for loans, the banking system is using lower funding costs to increase profits, and replenish capital, rather than to lend more. Like flooring the accelerator pedal in a stuck vehicle, more QE may just make the wheels spin faster in the global muck of debt and imbalances. There is no tow-truck in sight.