Monetary policy transmission in a world of endogenous money

Abstract

In Chapter 3, I questioned whether monetary policy transmits to the economy via the real balance effect. This chapter covers the question of how monetary policy can have an influence on interest rates in the absence of a real balance effect (that is, in this case, a Keynes effect) and how a change in interest rates translates to the real economy. The aim of this chapter is to provide a rationale for modelling monetary policy as a simple change in the interest rate. However, this chapter will not cover the restrictions a central bank faces when changing the short-term interest rate, as these will be covered in detail in Chapter 6.