bain_y_howells__monetary_economics__policy_and_its_theoretical_basis

204 MONETARY ECONOMICS
cause the consumption of all households and the investment of all firms to
increase, the overall relationship between interest rates and expenditure is a
negative and potentially powerful one. Much depends on the expectations
of households and firms regarding future changes in interest rates and the
likely direction the economy will take.
Although monetary authorities do not use the money supply as an instrument
of policy, much of the theoretical literature on the monetary transmission
mechanism assumes an exogenous money supply, manipulated by the
authorities. This literature remains important because it raises questions
concerning the likely usefulness and strength of monetary policy. The standard
approach, through the IS-LM model, concentrates on portfolio effects
and sees the transmission of money supply changes as occurring entirely
through the interest rate. The Keynesian speculative demand model raises
doubts about both the usefulness and strength of monetary policy - the former
because it allows the possibility of an unstable demand for money function,
the latter because it produces an argument for a highly interest-rateelastic
demand for money. This model has been criticized on several
grounds. One of these has been to argue that even pure monetary policy has
wealth effects and that there is a direct transmission of monetary policy
through wealth effects in addition to any transmission through interest rates.
In monetarist versions of the transmission mechanism the direct link
between the money supply and expenditure becomes the most important.
The chapter concludes with an outline of the theoretical approach to the
link between monetary policy, exchange rates and expenditure and with the
possibility of transmission occurring through credit availability rather than
through interest rates. Amongst the debate over monetary policy, we can
identify a number of positions, which can be summarized as:
Keynes:
Changes in the money supply are not likely to have a powerful effect on
aggregate demand particularly when the economy is in recession; the size of
any effect will be unpredictable since the demand for money function might
be unstable.
Neo-Keynesian (Tobin):
The effect of a change in the money supply on aggregate demand is both
more powerful and more predictable than in Keynes.
Monetarist:
The effect of a change in the money supply on expenditure is both direct and
powerful. However, monetarist economists recognize long and variable
time lags in policy, which lead them to prefer the operation of monetary pol-