Tight Monetary Policy

1. As a result of the subprime housing crisis, banks have cut back lending even to companies and individuals with top-flight credit ratings.  What does this imply about the degree of monetary policy tightness or ease in the present economic situation?

Subprime housing crisis

There is a good article here in Guardian, about how many firms are struggling to get credit for investment. This shortage of finance is causing a contraction in demand for money.

Traditionally ‘tight monetary policy’ involves high interest rates. This is because high interest rates reduce demand for money, causing lower borrowing and consumer spending. Tight monetary policy implies a conscious decision by the Federal reserve to raise rates.

See definition of tight monetary policy at investopedia

However, in the present situation, interest rates are very low (2% in US, 4.5% in UK). Yet, despite low interest rates, credit remains scarce because banks are unwilling to lend. The problem is not the cost of borrowing, but, the availability of credit. Thus, to firms it feels like there is a tight monetary policy, even though interest rates are very low.

For consumers, it is difficult to get finance. Though people with mortgages have more disposable income

Real Interest Rates

Also important to bear in mind real interest rates (nominal interest rates – inflation) because inflation is higher than nominal interest rates, the real rate of interest is negative, usually associated with loose monetary policy.

Effects of Higher Interest rates

An Evaluation of Monetary policy