Question

Question three Examine the spillover effect between the signaling and portfolio balance channel. (20 points)

Answer 1

Spill over effect refers to the impact of the seemingly unrelated events of a nation which may have on other economies. It promotes the engaging of economy in one behaviour which can affect the probability of engagement and disengaging of second behaviour in the economy.

Signalling refers to the idea which one party (agent) or economy conveys some information about itself to the another party (principal) or the economy.

Whereas, the portfolio balance channel refers to the situation when a short-term interest rate reaches zero, then the purchases of the Federal Reserve for the longer-term securities affects the financial condition or the situation of the economy at large.

The spill over effect between signalling and portfolio balance channel is the situation when the domestic factors of the economy such as, exchange rate and inflation gets affected by the situations of the economy. The transmission mechanism comes out to be useful for the portfolio balance channel in the case when knowledge of spill over return effect comes out to be useful for the asset allocation in the economy. As the consequence of which the Federal Reserve buys the securities of the long term and the other economies get to know about the financial condition of the economy.