Question

Please explain the monetary transmission mechanism? How does it work? URGENT Please

Answer 1

Monetary transmission mechanism explains the impact of change in money supply on output and inflation.

When the central bank conducts an expansionary (contractionary) monetary policy by open market purchase (sale) of securities, decreasing (increasing) required reserve ratio or decreasing (increasing) discount rate, it increases (decreases) the reserves in banking system available for lending. Higher (lower) reserves increase (decrease) credit lending, which increases (decreases) money supply.

Higher (lower) money supply shifts money supply curve to right (left), which decreases (increases) interest rate. Lower (higher) interest rate increases (decreases) investment demand, which in turn increases (decreases) aggregate demand. The AD curve shifts right (left), causing real GDP/output to increase (decrease) and price level to increase (decrease), thus decreasing (increasing) unemployment.