Transmission Mecanism

The transmission mechanism and the inflation rate.



Abstract



The point of this essay is to show the link between all components of the transmission mechanism, how interest rates, inflation, the GDP, inflation and unemployment are affected by the control of money supply and demand and what can offset inflationary measures in making adjustments. The other point is to explain the forces that are at play within an open economy and how different countries are affected by the decisions of a country’s policies.

Introduction



According to Lipsey et al.(1994:616),”The mechanism by which the demand and supply for money changes and affect aggregate demand is called the transmission mechanism”, there are a number of components that are affected by the way in which the demand and supply of money is changed.

“The components have an effect on each other and there is a reaction moving through a monetary policy whereby a monetary disequilibrium occurs, moving to a fall or rise in interest rates and due to the level of interest rates changing from the selling and buying of bonds, the next step arises from an increase or decrease in investment expenditure, creating a shift in aggregate expenditure and eventually the way that aggregate demand changes” (Lipsey et.al, 1999:616). The inflation outlook changes and there is a frustration of the adjustment mechanisms that can increase prices and inflation when it wasn’t intended (Tracer2, 2002:2).



The transmission mechanism and decreasing the interest rate.



In order for there to be a decrease in the interest rate there needs to first be money disequilibrium where by the money supply is increased by the South African Reserve Bank and this causes a fall in interest rates relative to other countries (Lipsey et.al, 1999:616). This also makes the interest earning assets less attractive than the assets in other countries and so the demand for South African...