bain_y_howells__monetary_economics__policy_and_its_theoretical_basis

7
7.1 Introduction
THE TRANSMISSION MECHANISM OF MONETARY POLICY 171
The Transmission
Mechanism of
Monetary Policy - I
‘A man who has more money about him than he requires is tempted
to spend it. It is apt to “burn a hole in his pocket”.’ S. Smiles, Thrift
(1875) viii p.125
What you will learn in this chapter:
• The ways in which interest rate changes affect consumption expenditure
• The ways in which interest rate changes affect investment expenditure
• The factors affecting the size of these changes
• The importance of degrees of confidence and expectations;
• The different views of the transmission mechanism assuming an exogenous
increase in the money supply
• The implications of these views for the demand for money
• The importance of the type of exchange rate system for the monetary
transmission mechanism
• The possibility of monetary policy changes being transmitted to expenditure
through the availability of credit.
We are concerned in this and the following chapter with what happens in the
economy following a change in monetary policy. We are particularly interested
in the impact that monetary policy has on the nominal income of the
economy and, through this, on the level of output and the rate of inflation.
The series of links between the monetary policy change and the changes in
output, employment, and inflation are known as the transmission mechanism
of monetary policy. This can be broken up into two elements — the
impact of monetary policy changes on aggregate demand; and the effect of
changes in aggregate demand on output, employment, and prices. In this
chapter, we consider the first of these. Chapter 8 looks at the second part of
the transmission mechanism.
We have seen that a monetary policy change may take one of three
forms: