Changes in financial and credit conditions can amplify cyclical swings in the economy and the effect of monetary policy, Federal Reserve Chairman Ben Bernanke said on Friday.
In a discussion of academic research on how a central bank's policies can affect an economy, Bernanke said financial conditions -- such as the ability of businesses or households to borrow easily at reasonable cost -- are central to economic health.
Bernanke did not discuss the outlook for the U.S. economy or interest rates in his speech, given to a highly academic conference of credit channel and monetary policy at the Federal Reserve Bank in Atlanta.
Asked after his speech about the effects of globalization in financial markets, Bernanke said globalization may change the way that shocks spread through the financial system, but it may also offset such shocks as risks are more dispersed.
"Given the globalization of the financial system, given individual investors can diversify their risks globally and across assets, the implications of shocks working through the financial system could be quite different today," he said.
"The mechanism of asset values could affect activity globally even if the shock is in the domestic market. At the same time, offsetting that globalization effect ... the overall impact on the economy might be reduced as no single borrower or intermediary will bear the brunt of the shock."
Incentives Needed to Make New Loans
In response to a separate question, Bernanke cautioned nonbank lenders, which unlike traditional banks may not hold loans in their portfolios but sell them off.
"It is important that originators have sufficient incentives to make new loans," he said.
In his speech, Bernanke said changes in financial conditions, such as tightening credit standards or sudden declines in asset values, are important in the propagation of the business cycle.
He also said many scholars believe changes in financial conditions may amplify the impact of monetary policy through a "financial accelerator" effect because changing asset values can affect the cost of credit, both for businesses and households.
As an example, Bernanke cited shifting home values.
He said home values may affect household borrowing and spending not only through a traditional "wealth effect" but also because they may have an impact on credit costs.
"Certainly, households with low mortgage loan-to-value ratios can borrow on relatively favorable terms through home-equity lines of credit, with the equity in their home effectively serving as collateral," Bernanke said.
"If the financial accelerator hypothesis is correct, changes in home values may affect household borrowing and spending by somewhat more than suggested by the conventional wealth effect because changes in homeowners' net worth also affect their external finance premiums and thus their costs of credit," he added.
Those effects would likely be greater in an economy where adjustable-rate mortgages are more widespread, such as Britain, than where fixed-rate mortgages are prevalent, such as the United States, Bernanke said.
"I do not think we know at this point whether, in the case of households, these effects are quantitatively significant in the aggregate," he said. "Certainly, these issues seem worthy of further study."