The reduction in the riskless short term rate caused

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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 deposits was not the relevant constraint on the supply of credit. Once 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...
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This note was uploaded on 11/23/2013 for the course ECON 11837649 taught by Professor Batchelder during the Spring '10 term at Pepperdine.

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