Edited by Philip Arestis and Malcolm Sawyer
Chapter 13: The Transmission Mechanism of Monetary Policy: A Critical Review
Greg Hannsgen* Recently, many economists have credited the late-1990s economic boom in the USA to the easy money policies of the Federal Reserve. On the other hand, it has been observed that very low interest rates have had very little eﬀect in improving the chronically weak Japanese economy. With those observations in mind, it would clearly be useful to have some theory of how money, monetary policy and interest rates aﬀect the economy. Most analyses of the way in which monetary policy aﬀects GDP and its components (the monetary transmission mechanism) assume that the central bank dictates the exact amount of money circulating at any given time. Post-Keynesian and other heterodox authors, in propounding the theory of endogenous money, argue instead that the central bank cannot control the money supply. Is there a theory of how money aﬀects the economy when it is endogenous (Arestis and Sawyer, 2004; forthcoming)? Since endogeneity implies that the amount of money in the economy adjusts to the demand for money, endogenous money theorists cannot base their theories on the notion that too much or too little money is in circulation. This amount is not subject to manipulation by policy. Instead, the eﬀects of monetary policy must arise because policy aﬀects interest rates. Since endogenous money theorists emphasize that money originates when credit is issued by banks, post-Keynesian monetary thinkers emphasize the eﬀects of interest rates on credit. Moreover, heterodox economists are most interested in the eﬀects...
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