money-supply/spending linkages

Money-supply/spending linkagesclick for a larger image
Fig. 129 Money-supply/spending linkages. See entry. (a) Rate of interest. (b) Planned investment. (c) National income.

money-supply/spending linkages

1 the indirect link (in the Keynesian view) between MONEY SUPPLY and AGGREGATE DEMAND through the INTEREST RATE. In brief, an increase in the money supply (from M to M1 in Fig. 129 (a)) brings about a fall in the rate of interest (from r to r 1), which results in an increase in planned INVESTMENT from I to I1 (Fig. 129). The rise in investment, in turn, increases aggregate demand and, via the MULTIPLIER effect, raises national income from Y to Y1 (Fig. 129). The fall in interest rates can also be shown to increase consumption expenditure (the lower cost of borrowing encourages people to use more LOAN finance to buy cars, televisions, etc.).


the direct link (in the monetarist view)

between the money supply and the level of aggregate demand. In brief, an increase in the money supply feeds directly into an increase in demand for final goods and services, and not just for investment goods. This proposition is based on the assumption that when households and businesses have more money than they need to hold, they will spend the excess on currently produced goods and services. See also TRANSMISSION MECHANISM, QUANTITY THEORY OF MONEY, MONETARISM, CROWDING-OUT EFFECT.