Question:
Extract of the Speech by Mr Thomas Jordan, Chairman of the Governing Board of the Swiss National Bank, at the Swiss Banking Global Symposium, Zurich, 16 November 2012.
"The crisis began in the financial sector, and it was possible to deploy expansionary monetary policy rapidly and effectively. As a consequence, central banks were in the front line right from the start. Following the collapse of Lehman Brothers in autumn 2008, they rapidly reduced short-term interest rates: in Switzerland, the US, the UK and Japan to almost zero percent; in the euro area and many other countries to historically low levels slightly above zero. The aim of these interest rate reductions was to stabilise the financial system and mitigate the looming deep recession. They also served to counter deflation expectations and prevent a negative price spiral.
With short-term nominal interest rates close to zero, further interest rate reductions were soon impossible. This meant that conventional monetary policy, in other words, managing the economy via short-term interest rates, was no longer an option."
(a) Use the Base multiplier framework for money supply to justify the choice of adoption of expansionary monetary policies in periods of financial crisis.
(b) Analyse interest rate as a traditional instrument for transmission mechanism for monetary policy. Discuss why the traditional interest rate channel proved to be inefficient during the global financial crisis. Support your answer with graphical appropriate representations.