8. Monetary Policy in Practice

Well-functioning monetary policy uses a combination of various tools and relies on a well-functioning banking sector, transmitting monetary policy targets into supply of credits that further affects real activities in the macroeconomy. This chapter gives a survey of the channels of monetary transmission mechanisms and shows how they work via various tools affecting intermediation in the banking sector, with a focus on the link between central bank’s balance sheet management and the transmission into the banking sector. Financial crises impede the resilience of the banking sector, interrupting standard transmission mechanisms and triggering huge spikes in credit spreads. This chapter illustrates this failure during the Great Recession and analyzes various unconventional policy responses, in particular the policy of qualitative and quantitative easing. These measures can drive the shadow rate (as a measure of the effective stance of monetary policy taking unconventional policies explicitly into account) into negative territory.