This preview shows page 1. Sign up to view the full content.
Unformatted text preview: lending, as shown in Figure 1, and an
increase in spreads, as shown in Figure 5. The resulting leftward shift of the IS curve
(Figure 4) meant a contraction of aggregate demand, despite the substantial cuts
in the federal funds rate shown in Figure 5. The reduction in the riskless short-term
rate caused an increased willingness to hold transactions deposits, and checkable
deposits increased substantially, as seen in Figure 1B. But plentiful deposits were
not enough to restore the flow of credit, for an inability to increase the volume of
deposits was not the relevant constraint on the supply of credit.
Once this process was underway—and given that, for a time, it appeared
that the crisis might spiral out of control—uncertainty about the macroeconomic
environment likely caused a further leftward shift of the IS curve, by increasing
precautionary saving and increasing the option value of deferring investment.
Once the IS curve shifted sufficiently far, it ceased to be possible to maintain 14 Under this analysis, the fact that the Fed did not tighten policy even further can be said to have contributed to the credit boom...
View Full Document