Curiosity 9.1: Does Excess Money Really Affect Spending?

		Figure 10.1 The Transmission Mechanism Monetary policy lowers the interest rate, increasing aggregate  demand for goods and services and setting the Keynesian  multiplier process in motion.

		In this new story, the impact of monetary policy is transmitted to economic activity through the intermediary of the interest rate. Most economists feel that this new transmission mechanism is the way in which monetary policy operates to influence economic activity; consequently, we adopt it henceforth in this book. The monetarist view of the transmission mechanism, described in chapter 9 as the modem quantity theory, can be seen to be consistent with this, but the explanation is too advanced for inclusion in this book. We shall simply view the chapter 9 story, in which people lower excess cash balances by spending them, as supplementing this interest-rate transmission mechanism.

		10.5 Monetary Policy Versus Fiscal Policy

		The view of discretionary monetary policy that has emerged from this chapter and the preceding two chapters is that through open-market operations the central bank can stimulate the economy by increasing the money supply, alternatively viewed as pushing down the interest rate. In a longer-run context an eye must be kept on the rate of growth of the money supply to ensure that inflation is not allowed to escalate, but in a noninflationary environment, discretionary use of monetary policy is a useful alternative or supplement to fiscal policy.

		Both fiscal and monetary policy shift the AD curve in the aggregate-supply/aggregate-demand diagram. Fiscal policy changes aggregate demand directly; monetary policy changes aggregate demand by changing the interest rate. Two marked differences between monetary and fiscal policy, however, should be noted.

		1. Timing considerations. Monetary policy can be implemented much more quickly than fiscal policy, since it does not require congressional approval. Once implemented, however, it affects the economy more slowly than fiscal policy because it takes time for decision makers to react to lower interest rates. It has been estimated, for example, that only about one-third of the impact of an interest rate change on aggregate demand occurs within one year, and only about one-half within two years. Furthermore, these lags are variable as well as long, making it quite difficult for monetary authorities to deduce