THE ECONOMICS OF MONEY,BANKING, AND FINANCIAL MARKETS 693

CHAPTER 25 Transmission Mechanisms of Monetary Policy 661 high Short-term interest rates that are near zero therefore not indicate that monetary policy is easy if the economy is undergoing deflation, as was true during the contraction phase of the Great Depression As Milton Friedman and Anna Schwartz have emphasized, the period of near-zero short-term interest rates during the contraction phase of the Great Depression was one of highly contractionary monetary policy rather than the reverse Other asset prices besides those of short-term debt instruments contain important information about the stance of monetary policy because they are important elements in various monetary policy transmission mechanisms As we have seen in this chapter, economists have come a long way in understanding that other asset prices besides interest rates have major effects on aggregate demand As we saw in Figure 25-3 (page 653), other asset prices, such as stock prices, foreign exchange rates, and housing and land prices, play an important role in monetary transmission mechanisms Furthermore, the discussion of such additional channels as those operating through the exchange rate, Tobin s q, and wealth effects provides additional reasons why other asset prices play such an important role in the monetary transmission mechanisms Although there are strong disagreements among economists about which channels of monetary transmission are the most important not surprising, given that economists, particularly those in academia, always like to disagree they agree that other asset prices play an important role in the way monetary policy affects the economy The view that other asset prices besides short-term interest rates matter has important implications for monetary policy When we try to assess the stance of policy, it is critical that we look at other asset prices in addition to short-term interest rates For example, if short-term interest rates are low or even zero and yet stock prices are low, land prices are low, and the value of the domestic currency is high, monetary policy is clearly tight, not easy Monetary policy can be highly effective in reviving a weak economy even if short-term interest rates are already near zero We have recently entered a world where inflation is not always the norm Japan, for example, recently experienced a period of deflation, when the price level was actually falling One common view is that when a central bank has driven down shortterm nominal interest rates to near zero, there is nothing more that monetary policy can to stimulate the economy The transmission mechanisms of monetary policy described here indicate that this view is false As our discussion of the factors that affect the monetary base in Chapter 16 indicated, expansionary monetary policy to increase liquidity in the economy can be conducted with open market purchases, which not have to be solely in short-term government securities For example, purchases of foreign currencies, like purchases of government bonds, lead to an increase in the monetary base and in the money supply This increased liquidity and a commitment to future expansionary monetary policy helps revive the economy by raising general price-level expectations and by reflating other asset prices, which then stimulate aggregate demand through the channels outlined here Therefore, monetary policy can be a potent force for reviving economies that are undergoing deflation and have short-term interest rates near zero Indeed, because of the lags inherent in fiscal policy and the political constraints on its use, expansionary monetary policy is the key policy action required to revive an economy experiencing deflation