 In the last few lectures, we have started a new topic that is transmission mechanism of monetary policy in which we have discussed interest rate channel as well as other asset price channel. Then in the last lecture, we started the third type of monetary policy transmission mechanism and that is credit view or credit channel. Within the credit channel, we have already discussed bank lending channel and now we move on to another channel which is also a credit channel. This is called balance sheet channel. Balance sheet channel main basic issue is that whenever monetary policy changes, then the net worth of the farms is changed. Net worth means that the final market value of assets and liabilities is different. Because of that, their net worth is changed. Now it is clear to you that we have said that financial frictions are due to asymmetric information and because of that, the process of lending becomes difficult and the lending comes down. So whenever net worth comes down from the firm, that means their balance sheet gets disturbed, net worth comes down, then the asymmetric information problem of financial frictions becomes more severe and that means that the lending becomes more effective. And the simple thing is that when the net worth of the farms comes down, then the collateral is not as much as the amount of loan that is required. So if the collateral is not available, then in that case, the lenders who have a selection procedure for lending, due to the lack of collateral, their adverse selection problem becomes more severe. Whereas the problem of moral hazard is also more. The reason for this is that because the stake of the farms is less, their net worth is less, if they get the loan, then because their equity is less, they can invest in more risky projects. So this means the problem of adverse selection is also severe, the problem of moral hazard is also more. The result is that the financial frictions increase and the financial frictions increase means that the lending becomes more problematic. Now in this case, if we discuss the balance sheet channel, then what can be the role of the monetary policy in this situation? So what will the monetary policy change? The monetary policy changes the interest rate. So the instrument of the monetary policy is that although the nominal interest rate changes, but if expectations are given, then the real interest rate will change. But real interest rate for example, decreases. Monetary policy, we say that the loss, the expansionary, real interest rate decreases. So in the case of real interest rate decreasing, we have already read that the prices of stock or other assets increase. We have discussed the channel in detail. This means the price of equity, the price of stock will increase when the real interest rate will decrease. And since the balance sheet of the firms, the stocks in the assets are equity, this means that the net worth of the firms will increase. When the net worth of the firms increases, then the problem of adverse selection for lenders decreases and the borrowers' moral hazard tendency decreases. What will be the result? Lending increases, investment increases, aggregate demand increases. So I had told you that in every transmission channel, there will be a new intervening or bridging variable. What is the net worth here? Now what we are reading on the credit channel, in which we have discussed the bank lending channel, in which we have discussed the balance sheet channel, there is another type of cash flow channel. So first let us understand what cash flow is. Look, the accounts of the firms have money receipts, that is, money inflow is also increasing, whereas the payments of the money are also increasing, that is, the money outflow is also increasing. So this inflow and outflow, outflow and inflow are the cash flows of the firms. Now how do we get net cash flows? Net cash flows are that the money receipts of the firms minus the payments of the money, then the net cash flows. So when the interest rate is low in the market, obviously due to the monetary policy, when the interest rate is low, then the cash outflow, the debt repayments and interest payments in the firm, the total amount is reduced in the net. Whereas on the other hand, if the inflows are not affected because they are coming from the other side, they are not interest based, that means the net cash flows of the firms will increase. Now the net cash flows increase, then it is called liquidity, that is, the chances of defaulting with the firms are reduced, that is, the net worth or net cash flows or its liquidity increases. So in such cases, then how does a channel of cash flow work? First of all, nominal interest rate is low. Now you have to keep in mind that I start every channel with real interest rate. This is the first channel in which I am starting with nominal interest rate and you should make it clear that the debt obligations of the firms are always in nominal terms. The bond of 100 rupees is 100 rupees only. If there is a 10% interest rate above that, then 10 rupees is to be paid extra. So in the nominal terms of 110 rupees, the inflation rate should be reduced. That means if the nominal interest rate is reduced, then the net cash flow of the firms increases. Now since the liquidity of the firms increases, that means the tendency of their moral hazard is reduced and the problem of lenders' adverse selection is also reduced. What is the result? There is more lending, there is more investment and the aggregate demand increases. Another channel in this is the credit rationing. The concept of credit rationing is that if the borrowers have the opportunity to invest, and that is why they are willing to pay higher interest, they are willing that they will pay more interest because we have such opportunities of business. But still the problem is that the problem for lenders is that the risky projects of the firms are generally ready to pay higher interest rates. This means that if the market has high interest rates and the high interest rates are ready to take borrowers' loans, then in the case of lenders, maybe these are risky investment firms, then they are ready to take loans on a higher interest rate. This means that the problem of adverse selection is more severe on a higher interest rate and because of that severity, the lenders are unable to lend and the credit rationing starts. Let's see what the monetary policy can do here. And how the transmission channel works in the credit rationing. So initially, we start from there that the monetary policy has changed its instrument, the real interest rate has decreased. The real interest rate that is less, then there is more risk of borrowing on a high interest rate. That is, the risk that the firms take tends to take loans on a high interest rate. So when the real interest rate has decreased in the market, then less risky projects will also start borrowing. Such firms will also borrow, which have less risky projects. This means less risk of borrowing increases. And the problem of adverse selection decreases. This means overall lending increases, investment increases, and ultimately aggregate demand increases. So this means, where does this channel come from? Risk versus less risk of borrowing. Or the investment in risky projects versus less risky projects works through this channel. Thank you.