Question

In the late $1990$ s, the stock market was rising rapidly, the economy was growing, and the Federal Reserve kept interest rates relatively low. Comment on how this policy stance would affect the economy as it relates to the Tobin $q$ transmission mechanisms.

Short answer

Tobin's q predicted that when inflation goes up and borrowing costs remain low, capital will rise, resulting in increased aggregate demand. Stock price increases will improve customer wealth, resulting in greater spending and inflationary pressures.

Step-by-step solution

Concept Introduction.

The mechanisms whereby the Federal Reserve System's monetary policies affect macroeconomic development are known as monetary policy channels.

Explanation of solution.

Tobin is the one to describe the relationship between economic growth and expenditure, and his reasoning is known as Tobin's $q$. Considering Tobin's $q$ and the impact of affluence on expansionary monetary policy, we have a consistent condition. Given low-interest rates and higher stock values, Tobin's $q$ predicted that capital would rise, resulting in increased aggregate demand.