bain_y_howells__monetary_economics__policy_and_its_theoretical_basis

THE TRANSMISSION MECHANISM OF MONETARY POLICY 173
assumed exogenous increase in the supply of money. Recently, it has been
suggested that the money supply might play a role in the transmission mechanism
even within a model constructed on the assumption of interest rate
control. This approach involves a distinction between a credit channel of
transmission (the impact of the change in interest rates) and a money channel
(second and later round effects on nominal income of money supply
changes that follow from the initial interest rate change). We look briefly at
this argument in Section 7.5. In Section 7.6, we return to the connection
between monetary policy and exchange rates, which is identified in 7.3 as
providing a possible transmission link. Section 7.7 discusses the possibility
of transmission occurring through credit availability.
7.2 The impact of a change in official interest rates on other
rates
In changing short-term interest rates - the interest rate on gilt sale and repurchase
agreements at the two-week maturity in the case of the Bank of
England (repo rate), the official refinancing rate (refi) in the case of the
European Central Bank — the monetary authorities expect to bring about
changes in the general level of interest rates in the economy. The link
between the short-term rate on which the central bank chooses to operate
and other interest rates in the economy is discussed in detail in Section 4.2.
There, we conclude that the effect of a change in the Bank's intervention rate
is an empirical question and may change over time. In general, short rates
adjust quite quickly and in the same direction as the official change. The
effect on medium and longer-term rates is much less certain. Although
there are exceptions (examples of which are given in 4.2), they, too, are likely
to move in the same direction but by smaller amounts than short rates.
The next step is to consider the effects on the economy of these changes in
interest rates brought about by central banks.
7.3 The impact of interest rate changes on consumption
and investment
It is widely accepted that this is influenced by changes in the real rate of
interest (the nominal rate of interest less the expected rate of inflation).
Changes in nominal interest rates brought about by central bank changes in
its short-term interest (repo) rate will, given the expected rate of inflation at
the time, result in changes in the real rate of interest in the economy. Thus,
we need to look at the ways in which real interest rate changes induced by