Question

Explain three channels of monetary policy transmission.

Answer 1

Monetary Transmission mechanism : has 3 stages:

1. Changes in MS or MD which results in changes in interest rates

2. Changes in interest rates, which leads to changes in Investment expenditure

3. Changes in investment expenditure shifts the Aggregate Demand curve.

The three channels of Monetary policy transmission are as follows:

1) Investment / savings channel

Decrease in cash rate results in fall in deposit rates , and therefore leads to decreased savings, whereas decrease in cash rate also leads to fall in borrowing rate and therefore Increased spending.

2) Cash Flow channel

Decrease in cash rate results in :

a)Borrowers cash flow channel: fall in mortgage rate, which leads to decrease in interest payments and therefore increases spending,

b)Lenders cash flow channel : results in fall in deposit rate , as result decrease in interest income and therefore decreases  spending.

3) Asset prices/ wealth channel :

Decrease in cash rate results in fall in lending rates, which leads to increase in house prices and therefore increased spending.