Answer to Question #146473 in Macroeconomics for Ndovhona

Question

The monetary transmission mechanism can be depicted in the form of a graph
or using symbols.
Explain, with the aid of symbols, the monetary transmission mechanism when
interest rates increase

Answer 1

The monetary transmission mechanism shows channels through which monetary policy affect the economy. Monetary policy affect national output and general price level by influencing variables such as interest rate, exchange rates, credit, monetary aggregates, and asset prices.

This, is described symplbolically as follows:

$M\uparrow \space \Rightarrow \space r \uparrow \space \Rightarrow \space I \uparrow \space \Rightarrow \space Y \uparrow$ where,

M is money supply, r is real interest rate, I is real investment, and Y is real output.

Thus, monetary policy increase money supply, money supply growth increses real interest rates, real interest rates increases real investment, and finally real investment growth increases national output.