Answer to Question #118355 in Macroeconomics for Kwesi junior

Question

What is the interest rate channel of monetary policy

Answer 1

Interest rate channel is an approach of monetary policies that enables policy-induced shifts in the short-term nominal interest rate by the Central Bank, affecting the price levels and consequently employment ad output. This mechanism changes the interest rates or/and the needed collateral that the central bank requires for emergency direct loans to banks in its function as the lender-of-last-resort. Charging higher rates and asking for more collateral implies that banks have to be more cautious with their risk failure or lending. Conversely, lending to banks at a lower rate and looser collateral requirements enables banks to get riskier loans at low rates and run with lower reserves. Thus, the interest rate channel of monetary policy is the link through which changes in central bank real interest rates affect aggregate output and prices.