The Monetary Transmission Process

Abstract

First, some definitions. Investment goods may be defined as all final goods with an expected life-time of more than one year. Consumption goods may be defined as all final goods with an expected life-time of less than one year. Consumption goods and investment goods thus exhaust total output. When saving is defined as income not consumed, it is immediately obvious why saving is identical to investment. Saving is not as it sounds a behavioral relationship, it is an accounting identity. Whenever there is an increase in investment the quantity of saving rises by the same amount. The question is, how does the increase in saving that satisfies the S ≡ I identity come about?

If the Keynes story is to be told properly (in its historical context) it should begin before Keynes. It begins with Hawtrey: Currency and Credit (1919). … Neither of them held that the economic system is automatically self-righting. … In Hawtrey as in Keynes, the system has to be stabilized, by policy and by some instrument of policy. It was over the instrument of this policy that they differed. As the difference began, it looked rather small. Both agreed that the instrument was a rate of interest, but Hawtrey looked to the short rate, Keynes to the long. At this point I would accept that Keynes was more up to date. … But then Keynes discovered that his long rate was not only less directly susceptible to banking control than Hawtrey’s short, but that it was very likely to be found that just when it was wanted, it could not move enough. So he moved away from monetary methods to the “fiscal” methods which have later been so associated with his name. … Thus it was that what began as monetary theory became “fiscalism.”

Sir John Hicks, 1976

Our desire to hold money as a store of wealth is a barometer of our distrust of our own calculationsand conventions concerning the future. … The possession of money lulls our disquietude.

John Maynard Keynes, 1937

The very notion of a “transmission mechanism” would be uncongenial to Keynes, for it suggests adichotomy between the monetary and real aspects of the economy, where he saw the economy as inherently monetary.

Victoria Chick, 1983: 327